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Uncertainty in financial markets makes portfolio diversification a valuable tool to navigate difficult market conditions. Diversification is probably the only free lunch in finance. It is closely related to asset segmentation: different representations of portfolio diversification are derived depending on what is considered the atom of asset allocation (capital / risk / factor). Probably a single measurement cannot provide a comprehensive representation.
Quantitative research at Amundi
This paper addresses management of sovereign wealth from the perspective of the theory of contingent claims. Starting with the sovereign’s balance sheet, we frame sovereign fund management as an asset-liability management (ALM) problem, covering all public entities and taking explicit account of all sources of risks affecting government resources and expenditures. Real-life SWFs asset allocations differ strongly from theoretical ones. Financial management of the sovereign balance sheet is hampered by a lack of aggregate data, which compromises the coordination of sovereign wealth management with fiscal policy, monetary policy and public debt management. In this framework, we suggest institutional arrangements that could overcome this obstacle and enable efficient coordination.
Zvi BODIE, Marie BRIERE
This paper sets out a new analytical framework for optimal asset allocation of sovereign wealth, based on the theory of contingent claims analysis (CCA) applied to the sovereign’s economic balance sheet. A country solves an asset-liability management (ALM) problem involving its sources of income and its expenditures. We derive analytically the optimal asset allocation of sovereign wealth, taking explicit account of all sources of risks affecting the sovereign’s balance sheet. The optimal composition of sovereign wealth should involve a performance-seeking portfolio and three hedging demand terms for the variability of the fiscal surplus, and external and domestic debt. Our results provide guidance for sovereign wealth management, particularly with respect to sovereign wealth funds and foreign exchange reserves. A real-life application of our model in the case of Chile shows that at least 60% ofthe Chilean asset allocation should be dedicated to emerging bonds, developed and emerging equities. At present, Chile’s sovereign investment is under-diversified.
Marie BRIERE, Zvi BODIE