Financial market shocks and portfolio rebalancing

Publication Date

1-1-2023

Document Type

Article

Publication Title

Managerial Finance

DOI

10.1108/MF-08-2023-0470

Abstract

Purpose: The intention of the empirics is to contribute to the general understanding of investor responses to market price shocks. The authors review assumptions about investor behavior in response to price shocks and investigate alternative rebalancing heuristics. Design/methodology/approach: The authors use market data over 40 years to define market shocks. Portfolio rebalancing implements constrained Markowitz mean-variance (MV) heuristics. Findings: Momentum rebalancing in portfolio management outperforms contrarian rebalancing in the study interval. Sensitivity analysis by decade, sector constraints and proportion of security holdings bought or sold continue to support momentum rebalancing. Research limitations/implications: The results are consistent with under-responding to price shocks at consensus levels in financial markets. The theoretical background provides a basis for experimental lab studies of shocks of different magnitudes under conditions in which participants have information on the levels of other participants and a condition in which they can only observe their previous estimates. Practical implications: Managing portfolios in the face of price disturbances of different magnitudes is informed by empirical studies and their implications for investor behavior. Originality/value: This is the first study the authors can locate that uses market data with alternative rebalancing heuristics to estimate price returns from the respective heuristics over a time interval of 40 years. The authors support the results with sensitivity estimates and consider implications for the underlying agent heuristics in light of background studies.

Funding Sponsor

Lucas Foundation

Keywords

Financial market shocks, Portfolio rebalancing, Portfolio total returns, Time-delay rebalancing

Department

Marketing and Business Analytics

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