Optimal constrained strategies for factor-based investing in the Brazilian stock market
ABSTRACT The paper examines investment strategies for factor-based portfolios formed by integrating a regime-switching model with a stochastic recursive utility function. Drawing from the seminal works of Fama and French (1993) and Carhart (1997), the authors identify four risk factors within the Br...
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Universidade de São Paulo
2024-12-01
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| Series: | Revista Contabilidade & Finanças |
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| author | Marcelo Lewin Carlos Heitor Campani |
| author_facet | Marcelo Lewin Carlos Heitor Campani |
| author_sort | Marcelo Lewin |
| collection | DOAJ |
| description | ABSTRACT The paper examines investment strategies for factor-based portfolios formed by integrating a regime-switching model with a stochastic recursive utility function. Drawing from the seminal works of Fama and French (1993) and Carhart (1997), the authors identify four risk factors within the Brazilian stock market. Subsequently, employing the CGL model proposed by Campani et al. (2021), the study develops investment strategies to diversify across portfolios formed with these risk factors. The CGL model provides the framework to apply the stochastic recursive utility function to estimate the strategies based on regimes, from which the authors implement dynamic constraints to optimally control the portfolio weights. They then conduct a performance analysis through an out-of-sample exercise to compare the regime-switching strategies with benchmarks formed by single-state passive and active strategies. The empirical findings demonstrate the outperformance of regime-switching strategies, as evidenced by superior Sharpe ratios across both the complete sample and shorter subsamples within the exercise. The results also reveal that the unleveraged regime-switching strategy consistently exhibits the lowest volatility within each sample subset. In addition, the analysis of certainty equivalent returns confirms the statistical significance of the outperformance of regime-switching strategies over the benchmarks. The investigation focused on the Brazilian stock market to examine the potential benefits and efficacy of applying such a strategy in an emerging market context. Ultimately, the findings underscore that factor-based strategies formulated through a regime-switching model using a stochastic recursive utility function have the potential to outperform traditional benchmarks in terms of risk-adjusted returns within the Brazilian stock market, offering actionable insights for investors navigating the Brazilian landscape. |
| format | Article |
| id | doaj-art-c2d6b8e013564e62b3bcedc664c928f6 |
| institution | OA Journals |
| issn | 1808-057X |
| language | English |
| publishDate | 2024-12-01 |
| publisher | Universidade de São Paulo |
| record_format | Article |
| series | Revista Contabilidade & Finanças |
| spelling | doaj-art-c2d6b8e013564e62b3bcedc664c928f62025-08-20T02:36:53ZengUniversidade de São PauloRevista Contabilidade & Finanças1808-057X2024-12-01359610.1590/1808-057x20242051.enOptimal constrained strategies for factor-based investing in the Brazilian stock marketMarcelo Lewinhttps://orcid.org/0000-0003-1699-8832Carlos Heitor Campanihttps://orcid.org/0000-0003-1896-7837ABSTRACT The paper examines investment strategies for factor-based portfolios formed by integrating a regime-switching model with a stochastic recursive utility function. Drawing from the seminal works of Fama and French (1993) and Carhart (1997), the authors identify four risk factors within the Brazilian stock market. Subsequently, employing the CGL model proposed by Campani et al. (2021), the study develops investment strategies to diversify across portfolios formed with these risk factors. The CGL model provides the framework to apply the stochastic recursive utility function to estimate the strategies based on regimes, from which the authors implement dynamic constraints to optimally control the portfolio weights. They then conduct a performance analysis through an out-of-sample exercise to compare the regime-switching strategies with benchmarks formed by single-state passive and active strategies. The empirical findings demonstrate the outperformance of regime-switching strategies, as evidenced by superior Sharpe ratios across both the complete sample and shorter subsamples within the exercise. The results also reveal that the unleveraged regime-switching strategy consistently exhibits the lowest volatility within each sample subset. In addition, the analysis of certainty equivalent returns confirms the statistical significance of the outperformance of regime-switching strategies over the benchmarks. The investigation focused on the Brazilian stock market to examine the potential benefits and efficacy of applying such a strategy in an emerging market context. Ultimately, the findings underscore that factor-based strategies formulated through a regime-switching model using a stochastic recursive utility function have the potential to outperform traditional benchmarks in terms of risk-adjusted returns within the Brazilian stock market, offering actionable insights for investors navigating the Brazilian landscape.http://www.scielo.br/scielo.php?script=sci_arttext&pid=S1519-70772024000300509&lng=en&tlng=enregime-switching modelsrisk factorsstochastic differential recursive utilitydynamic asset allocationleverage and portfolio constraints |
| spellingShingle | Marcelo Lewin Carlos Heitor Campani Optimal constrained strategies for factor-based investing in the Brazilian stock market Revista Contabilidade & Finanças regime-switching models risk factors stochastic differential recursive utility dynamic asset allocation leverage and portfolio constraints |
| title | Optimal constrained strategies for factor-based investing in the Brazilian stock market |
| title_full | Optimal constrained strategies for factor-based investing in the Brazilian stock market |
| title_fullStr | Optimal constrained strategies for factor-based investing in the Brazilian stock market |
| title_full_unstemmed | Optimal constrained strategies for factor-based investing in the Brazilian stock market |
| title_short | Optimal constrained strategies for factor-based investing in the Brazilian stock market |
| title_sort | optimal constrained strategies for factor based investing in the brazilian stock market |
| topic | regime-switching models risk factors stochastic differential recursive utility dynamic asset allocation leverage and portfolio constraints |
| url | http://www.scielo.br/scielo.php?script=sci_arttext&pid=S1519-70772024000300509&lng=en&tlng=en |
| work_keys_str_mv | AT marcelolewin optimalconstrainedstrategiesforfactorbasedinvestinginthebrazilianstockmarket AT carlosheitorcampani optimalconstrainedstrategiesforfactorbasedinvestinginthebrazilianstockmarket |