Global Tactical Asset Allocation Assignment 1 Country Risk

Global Tactical Asset Allocation Assignment 1 Country Risk Indices and Portfolio Management CRIIP Ernesto Cadeiras Matias Correa Sugio Suzuki Sandeep Toshniwal

International Country Risk Guide • Three different risks: financial, political and economical • Based on a compilation of 24 risk factors; 5 financial, 13 political and 6 economical • Issued monthly • A composite risk index is also calculated as a weighted average of all the factors

Our Goal • Use the ICRG Risk Ratings to: – Forecast returns on MSCI index for 18 countries using the changes ICRG ratings – Forecast the 1 -year ahead volatility (variance) on the monthly returns on the MSCI index • Test the performance of portfolios of countries based on the direction of the change in the composite rating

Forecasting Returns • Early in our analysis we found out that: – The models had very bad performance insample – Specifically the economical risk rating was insignificant • Based on these findings we tested 4 models to forecast returns

The Models Independent Variables: • Model 1: Change in the political and financial rating • Model 2: Change in all 3 ratings • Model 3: Value of the 3 ratings • Model 4: Value of the political and financial ratings

The Results

Forecasting Volatility • We tested two models to forecast volatility – Model 1: Values of the three ratings – Model 2: Changes in the three ratings • Model 1 had an impressive performance (insample) • When we tested out-of-sample, model 2 was actually better than model 1

Portfolio Comparisons $1, 300 Returns (base $100 - Jan. '84) $1, 100 $900 Portfolio -1 MSCI World $700 Portfolio +1 $500 $300 $100 0. 15% 0. 20% 0. 25% 0. 30% Variance 0. 35% 0. 40%

Conclusions • Our results show worse performance than the models we tested in assignment 3 • Some (not few) of the coefficients were positive • There seems to be some forecasting power in the changes in the ratings – Variable is too discrete

Netherlands, Model 1 Plot of Yr. Ret observed 0. 82 0. 62 0. 42 0. 22 0. 02 -0. 18 0. 02 0. 22 0. 42 predicted 0. 62 0. 82