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The costs of suboptimal dynamic asset allocation: General results and applications to interest rate risk, stock volatility risk, and growth/value tilts

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  • Larsen, Linda Sandris
  • Munk, Claus

Abstract

The recent theoretical asset allocation literature has derived optimal dynamic investment strategies in various advanced models of asset returns. But how sensitive is investor welfare to deviations from the theoretically optimal strategy? Will unsophisticated investors do almost as well as sophisticated investors? This paper develops a general theoretical framework for answering such questions and applies it to three specific models of interest rate risk, stochastic stock volatility, and mean reversion and growth/value tilts of stock portfolios. Among other things, we find that growth/value tilts are highly valuable, but the hedging of time-varying stock risk premia is less important.

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Bibliographic Info

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

Volume (Year): 36 (2012)
Issue (Month): 2 ()
Pages: 266-293

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Handle: RePEc:eee:dyncon:v:36:y:2012:i:2:p:266-293

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Web page: http://www.elsevier.com/locate/jedc

Related research

Keywords: Suboptimal investments; Wealth-equivalent utility loss; Stochastic interest rates; Stochastic volatility; Growth and value stocks; Mean reversion in stock returns;

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References

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Cited by:
  1. Ascheberg, Marius & Branger, Nicole & Kraft, Holger, 2013. "When do jumps matter for portfolio optimization?," SAFE Working Paper Series 16, Research Center SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt.
  2. Christian Flor & Linda Larsen, 2014. "Robust portfolio choice with stochastic interest rates," Annals of Finance, Springer, vol. 10(2), pages 243-265, May.

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