Exploiting predictability in international anomalies.

Abstract

We construct unconditionally e±cient asset allocation strategies that ex- ploit return predictability of international size and momentum portfolios. The strategies achieve comparable returns to these investment assets while exhibit- ing much lower volatility. They largely avoid major losses by successfully tim- ing these assets. The strategies utilizing the MSCI world index and the term spread as predictive variables achieve better performance than those without exploiting return predictability. The optimal strategies perform better than conditionally e±cient strategies due the conservative response of the optimal portfolio weight to extreme realizations of the predictive variables, thus leading to lower volatility.