Asset-Allocation Decisions When Risk Is Changing

Various risk estimation methods have been proposed in response to evidence that risk is changing. We investigate the effect of alternative risk-estimation methods in the context of asset-allocation decisions that seek to minimize portfolio risk. The risk measures considered include the traditional fixed-window method, exponential smoothing, and GARCH. Our findings confirm that the choice of risk measure can make a significant difference to the efficiency of asset-allocation decisions and therefore to investment outcomes and fund rankings. We find that the traditional fixed-window method is rarely optimal and that measures that account for volatility clustering are generally preferable.