Download The parameter sensitivity of the Margrabe Best-of

The parameter sensitivity of the Margrabe Best-of-two strategy
Giang Nguyen
The Margrabe Best-of-two strategy is a rule-based dynamic investment solution for the two-asset
allocation problem. Its typical implementation involves yearly rebalancing the portfolio weights to 50-50
at the beginning of the year. While the yearly rebalancing corresponds to a reversal trade, the intra-year
weight adjustments chase the momentum of the best performing asset by replicating the value of
Margrabe option to exchange an asset for another. In practice, this means that the Margrabe portfolio
allocation depends on assets’prices, their return volatilities and correlation as well as the remaining time
until year-end. In this paper, we study the sensitivity of the strategy to these input parameters, both
analytically and through numeric experiments. We also report the results of an extensive out-of-sample
evaluation for the bond-equity investment problem, where we compare the Margrabe Best-of-two
strategy with alternative solutions to the two-asset allocation problem.