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Strategic asset allocation in a continuous-time VAR model

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  • Campbell, John Y.
  • Chacko, George
  • Rodriguez, Jorge
  • Viceira, Luis M.

Abstract

This note derives an approximate solution to a continuous-time intertemporal portfolio and consumption choice problem. The problem is the continuous-time equivalent of the discrete-time problem studied by Campbell and Viceira (1999), in which the expected excess return on a risky asset follows an AR(1)process, while the riskless interest rate is constant. The note also shows how to obtain continuous-time parameters that are consistent with discrete-time econometric estimates. The continuous-time solution is numerically close to that of Campbell and Viceira and has the property that conservative long-term investors have a large positive intertemporal hedging demand for stocks.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 28 (2004)
Issue (Month): 11 (October)
Pages: 2195-2214

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Handle: RePEc:eee:dyncon:v:28:y:2004:i:11:p:2195-2214

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References

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  1. Campbell, John & Viceira, Luis, 1999. "Consumption and Portfolio Decisions When Expected Returns are Time Varying," Scholarly Articles 3163266, Harvard University Department of Economics.
  2. Duffie, Darrell & Epstein, Larry G, 1992. "Asset Pricing with Stochastic Differential Utility," Review of Financial Studies, Society for Financial Studies, vol. 5(3), pages 411-36.
  3. Wachter, Jessica A., 2002. "Portfolio and Consumption Decisions under Mean-Reverting Returns: An Exact Solution for Complete Markets," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 37(01), pages 63-91, March.
  4. George Chacko & Luis M. Viceira, 2005. "Dynamic Consumption and Portfolio Choice with Stochastic Volatility in Incomplete Markets," Review of Financial Studies, Society for Financial Studies, vol. 18(4), pages 1369-1402.
  5. Campbell, John Y. & Viceira, Luis M., 2002. "Strategic Asset Allocation: Portfolio Choice for Long-Term Investors," OUP Catalogue, Oxford University Press, Oxford University Press, number 9780198296942, October.
  6. John Y. Campbell & Yeung Lewis Chan & Luis M. Viceira, 2001. "A Multivariate Model of Strategic Asset Allocation," NBER Working Papers 8566, National Bureau of Economic Research, Inc.
  7. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, Econometric Society, vol. 57(4), pages 937-69, July.
  8. R. C. Merton, 1970. "Optimum Consumption and Portfolio Rules in a Continuous-time Model," Working papers 58, Massachusetts Institute of Technology (MIT), Department of Economics.
  9. John Y. Campbell & Albert S. Kyle, 1988. "Smart Money, Noise Trading and Stock Price Behavior," NBER Technical Working Papers 0071, National Bureau of Economic Research, Inc.
  10. Kim, Tong Suk & Omberg, Edward, 1996. "Dynamic Nonmyopic Portfolio Behavior," Review of Financial Studies, Society for Financial Studies, vol. 9(1), pages 141-61.
  11. Bergstrom, A.R., 1984. "Continuous time stochastic models and issues of aggregation over time," Handbook of Econometrics, Elsevier, in: Z. Griliches† & M. D. Intriligator (ed.), Handbook of Econometrics, edition 1, volume 2, chapter 20, pages 1145-1212 Elsevier.
  12. Viceira, Luis & Campbell, John, 2001. "Who Should Buy Long-Term Bonds?," Scholarly Articles 3128709, Harvard University Department of Economics.
  13. Epstein, Larry G & Zin, Stanley E, 1991. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: An Empirical Analysis," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 99(2), pages 263-86, April.
  14. Duffie, Darrel & Lions, Pierre-Louis, 1992. "PDE solutions of stochastic differential utility," Journal of Mathematical Economics, Elsevier, vol. 21(6), pages 577-606.
  15. Duffie, Darrell & Epstein, Larry G, 1992. "Stochastic Differential Utility," Econometrica, Econometric Society, Econometric Society, vol. 60(2), pages 353-94, March.
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Citations

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Cited by:
  1. Eduardo Walker, 2006. "Optimal Portfolios In Defined Contribution Pension Systems," Abante, Escuela de Administracion. Pontificia Universidad Católica de Chile., Escuela de Administracion. Pontificia Universidad Católica de Chile., vol. 9(2), pages 99-129.
  2. Jakub W. Jurek & Luis M. Viceira, 2011. "Optimal Value and Growth Tilts in Long-Horizon Portfolios," Review of Finance, European Finance Association, European Finance Association, vol. 15(1), pages 29-74.
  3. Ferstl, Robert & Weissensteiner, Alex, 2011. "Asset-liability management under time-varying investment opportunities," Journal of Banking & Finance, Elsevier, vol. 35(1), pages 182-192, January.
  4. Branger, Nicole & Grüning, Patrick & Kraft, Holger & Meinerding, Christoph, 2013. "Asset pricing under uncertainty about shock propagation," SAFE Working Paper Series 34, Research Center SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt.
  5. Hoevenaars, Roy P.M.M. & Molenaar, Roderick D.J. & Schotman, Peter C. & Steenkamp, Tom B.M., 2008. "Strategic asset allocation with liabilities: Beyond stocks and bonds," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 32(9), pages 2939-2970, September.
  6. Jessica A. Wachter, 2010. "Asset Allocation," Annual Review of Financial Economics, Annual Reviews, vol. 2(1), pages 175-206, December.
  7. Maenhout, Pascal J., 2006. "Robust portfolio rules and detection-error probabilities for a mean-reverting risk premium," Journal of Economic Theory, Elsevier, vol. 128(1), pages 136-163, May.
  8. Bernd Scherer, 2009. "A note on portfolio choice for sovereign wealth funds," Financial Markets and Portfolio Management, Springer, vol. 23(3), pages 315-327, September.
  9. Jaime A. Londo\~no, 2006. "State Dependent Utility," Papers math/0603316, arXiv.org.
  10. Hening Liu, 2010. "Robust consumption and portfolio choice for time varying investment opportunities," Annals of Finance, Springer, vol. 6(4), pages 435-454, October.
  11. Weidong Xu & Hongyi Li & Chongfeng Wu, 2011. "A Robust General Equilibrium Stochastic Volatility Model with Recursive Preference Investors," Annals of Economics and Finance, Society for AEF, vol. 12(2), pages 217-231, November.
  12. Alois Geyer & Michael Hanke & Alex Weissensteiner, 2009. "A stochastic programming approach for multi-period portfolio optimization," Computational Management Science, Springer, vol. 6(2), pages 187-208, May.
  13. Luca Benzoni & Pierre Collin-Dufresne & Robert S. Goldstein, 2005. "Portfolio Choice over the Life-Cycle in the Presence of 'Trickle Down' Labor Income," NBER Working Papers 11247, National Bureau of Economic Research, Inc.
  14. Sørensen, Carsten & Trolle, Anders Bjerre, 2006. "Dynamic asset allocation and latent variables," Working Papers, Copenhagen Business School, Department of Finance 2004-8, Copenhagen Business School, Department of Finance.

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