HEC Research Papers Series,
HEC Paris

Abstract: Designing an investment strategy in transition economies is a difficult task because stock-markets opened through time, time series are short, and there is little guidance how to obtain expected returns and covariance matrices necessary for mean-variance portfolio allocation. Also, structural breaks are likely to occur. We develop an ad-hoc investment strategy with a flavor of Bayesian learning. An observation is that often an extreme event will herald a new state of the economy. We use this observation to re-initialize learning when unlikely returns materialize. By using a Cornell benchmark, we are able to show the usefulness of our strategy for certain types of re-initializations.

Keywords: mean-variance allocation; portfolio choice; transition economies

JEL-codes: C11; C32; F30; G11

36 pages, October 1, 2001

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