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Abstract
Tactical asset allocators operate on the assumption that if risk premiums increase, higher-rated bonds will outperform lower-rated bonds, and that if risk premiums decrease, the reverse will happen. Empirical testing shows, however, that about 30% of the time, these expected relationships break down. Drawing on a classic debate among corporate bond market participants, investors might hypothesize that tactical asset allocators can improve their results by classifying bonds according to market-based risk premiums rather than by agency-generated ratings. In the context of tactical asset allocation, however, Fridson and Mcleod-Salmon do not find the market to be a shrewder judge of credit risk than the rating agencies. The solution to the problem of perverse outcomes in credit-oriented tactical asset allocation may be to combine top-down sector selection techniques with bottom-up security selection.
TOPICS: Portfolio theory, fixed-income portfolio management, analysis of individual risk factors/risk premia
- © 2011 Pageant Media Ltd
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