Global Tactical Asset AllocationAssignment 1

Country Risk Indices and Portfolio Management

CRIIPErnesto Cadeiras

Matias CorreaSugio 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 in-

sample– 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

Model In-Sample Out-of-Sample

1 Poor Best

2 Poor 2nd Best

3 Best Poor

4 2nd Best Poor

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 (in-sample)

• When we tested out-of-sample, model 2 was actually better than model 1

Portfolio Comparisons

MSCI World

Portfolio 0

Portfolio +1

Portfolio -1

$100

$300

$500

$700

$900

$1,100

$1,300

0.15% 0.20% 0.25% 0.30% 0.35% 0.40%

Variance

Ret

urns

(bas

e $1

00 -

Jan.

'84)

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 YrRet

predicted

obse

rved

-0.18 0.02 0.22 0.42 0.62 0.82-0.18

0.02

0.22

0.42

0.62

0.82