Active Portofolio Management in the Presence of Regime Switching: What Are the Benefits of Defensive Asset Allocation Strategies If the Investor Faces Bear Markets?

This paper studies the asset allocation decision in the presence of regime switchingin stock market returns. The analysis is based on two stock indices: DJI 30 and OMX30. The two-step optimization procedure employed points towards the usage of defensiveasset allocation strategies under bear markets and ordinary index tracking strategies underbull markets. The out-of-sample experiments strengthen the performance of active strategiesthat distinguish between different regimes. Moreover, the Sharpe ratios of portfolios basedon such strategies are higher than the ones of ordinary index tracking based portfolios.