Adaptive Asset Allocation Under Abrupt Stock-Bond Correlation Reversals Using the Markowitz Framework

Markowitz Mean-Variance Model was proposed by Harry Markowitz. As a modern portfolio theory with important practical application value, the core content of Markowitz mean-variance model includes that investors can reduce non-systemic risks and help investors pursue higher returns by diversifying investment. This paper emphasizes how the theory can be applied flexibly under the actual extreme market. Firstly, this paper analyzes the correlation between assets through the example of the stock and bond market, find the reason for the traditional negative correlation between stocks and bonds. And then discusses the abnormal correlation between stocks and bonds triggered in extreme market periods. Next , essay focus on how investors judge the market environmental conditions, and then use the diversification of investment in Markowitz's theory to reduce risk. The discussion reveals that, the factors contributing to the weakening of the correlation between stocks and bonds include sudden changes in monetary policy, economic recession or rising inflation rates. Even worse, there is a possibility that the correlation could turn from negative to positive. When the correlation between assets changes, the return rate of traditional portfolio investors is greatly affected, and investors need to re-optimize the asset weight to reduce risk or increase the sharpe ratio. And At such times, the hedging and stable income-generating functions of traditional investment portfolios are weakened, and their effectiveness drops significantly. In order to continue to effectively avoid risk in extreme market environments, this article will discuss the importance of inflation-resistant assets, and suggest adding alternative assets such as gold and commodities to your asset allocation to hedge investment risks.