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Return predictability and intertemporal asset allocation: Evidence from a bias-adjusted VAR model

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  • Engsted, Tom
  • Pedersen, Thomas Q.

Abstract

Within a VAR based intertemporal asset allocation model we explore the effects on return predictability and optimal asset allocation of adjusting VAR parameter estimates for small-sample bias. We apply a simple and easy-to-use analytical bias formula instead of bootstrap or Monte Carlo bias-adjustment. Regarding return predictability we show that bias-adjustment in the multivariate setup can yield very different results than in the univariate case. Furthermore, bias-correcting the VAR parameters has both quantitatively and qualitatively important effects on the optimal portfolio choice. For intermediate values of risk-aversion, the intertemporal hedging demand for bonds and stocks is heavily affected by the bias-correction. Utility calculations also show large effects of bias-adjustment, both in-sample and out-of-sample.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Empirical Finance.

Volume (Year): 19 (2012)
Issue (Month): 2 ()
Pages: 241-253

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Handle: RePEc:eee:empfin:v:19:y:2012:i:2:p:241-253

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

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Keywords: Intertemporal portfolio choice; Return predictability; VAR model; Small-sample bias; Utility calculations; Out-of-sample evaluation;

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Cited by:
  1. Thomas Q. Pedersen, 2010. "Predictable return distributions," CREATES Research Papers 2010-38, School of Economics and Management, University of Aarhus.
  2. Tom Engsted & Thomas Q. Pedersen, 2011. "Bias-correction in vector autoregressive models: A simulation study," CREATES Research Papers 2011-18, School of Economics and Management, University of Aarhus.
  3. Thomas Q. Pedersen, 2008. "Intertemporal Asset Allocation with Habit Formation in Preferences: An Approximate Analytical Solution," CREATES Research Papers 2008-60, School of Economics and Management, University of Aarhus.
  4. Michael D. Bauer & Glenn D. Rudebusch & Jing (Cynthia) Wu, 2011. "Unbiased estimate of dynamic term structure models," Working Paper Series 2011-12, Federal Reserve Bank of San Francisco.

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