Equity Valuation and Portfolio Management

MODELING AFTER THE 2007–2009 GLOBAL FINANCIAL CRISIS

The period following the 2007–2009 global financial crisis has witnessed the acceleration of a number of modeling trends identified in previous research by Fabozzi, Focardi, and Jonas. In particular, the growing awareness of the nonnormal nature of returns is fueling efforts to adopt models and risk measures able to cope with nonlinearity. Among these are conditional value-at-risk (CVaR) to measure risk and copula functions to measure co-movements. Regime shifting models, which are in principle able to capture transitions from one regime to another, for example from stable to volatile market states, are increasingly being considered as a modeling option. Modelers also sought to find new factors and new predictors (hopefully unique), using new data sources, in particular from the derivatives market. However, as equity markets began to rebound in 2010, modeling strategies that essentially work in growth markets were back in favor. This includes strategies such as equal-weighted portfolios that benefit from both mean reversion and upward market valuations.

The 2007–2009 global financial crisis underlined the importance of asset allocation in explaining returns. The renewed awareness of the overwhelming importance of asset allocation, compared to, for example, stock selection or execution, has accelerated the adoption of dynamic asset allocation. According to the paradigm of dynamic asset allocation, investors switch into and out ...