Portfolio diversification during monetary loosening policy

Abstract

Purpose

The purpose of the paper is to analyze the impact of quantitative easing (QE) performed in the USA on relationship between assets mainly from mining and oil industries. Based on the empirical results, the method of diversified portfolio creation has been proposed.

Design/methodology/approach

Nine DCC-GARCH-type models have been estimated for each group centered around a main asset: a company from the oil or mining industry, the appropriate currency pair for its market of origin, commodities which could be used for the diversification of risk involved in investing in a portfolio containing the company, and the largest company from the same industry listed on the US market. Each series of conditional correlations was analyzed with regard to the changes that occurred during the various stages of QE.

Findings

The correlations are shown to be stabilizing in the successive stages of QE. The most significant changes in the distribution of correlations can be observed after the first stage of QE. The effects of QE are evident not only in the USA but also in other countries; however, the level of its influence varies between different markets and assets. It is possible to diversify the inflation, currency and market portfolio risk by appropriately chosen asset decomposition.

Research limitations/implications

The DCC model is limited, so to provide more precise results, more sophisticated models can be estimated and compared.

Practical implications

The paper investigate the fact of stabilization in financial markets relations. The findings may prove the validity of continuation of QE. A portfolio creation method has been proposed – it has been stated that including commodity in portfolio is more appropriate then only-bond–equity mix.

Originality/value

The new approach of analyzing financial stability has been proposed – the control for stability of conditional correlation.

Citation

Makiel, K. (2015), "Portfolio diversification during monetary loosening policy", Journal of Risk Finance, Vol. 16 No. 2, pp. 197-214. https://doi.org/10.1108/JRF-08-2014-0121