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Portfolio choice with stochastic interest rates and learning about stock return predictability

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  • Escobar, Marcos
  • Ferrando, Sebastian
  • Rubtsov, Alexey

Abstract

We analyze how investors should optimally choose to invest under the assumptions that interest rates are stochastic and stock returns are predictable with observed and unobserved factors. The stock risk premium is taken to be an affine function of the predictive variables and the stock return volatility is assumed to depend on the observed factor. The latent factor is estimated based on the observations. It is shown that stock return predictability can significantly impact the optimal bond portfolio. Considerable welfare benefits may arise from using bonds in learning about/hedging against stock return predictors.

Suggested Citation

  • Escobar, Marcos & Ferrando, Sebastian & Rubtsov, Alexey, 2016. "Portfolio choice with stochastic interest rates and learning about stock return predictability," International Review of Economics & Finance, Elsevier, vol. 41(C), pages 347-370.
    • Handle: RePEc:eee:reveco:v:41:y:2016:i:c:p:347-370
    DOI: 10.1016/j.iref.2015.07.003
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    2. Huang, Jia & Chen, Zheng, 2021. "Optimal risk asset allocation of a loss-averse bank with partial information under inflation risk," Finance Research Letters, Elsevier, vol. 38(C).

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    More about this item

    Keywords

    Portfolio choice; Stochastic interest rates; Return predictability; Learning; Welfare loss;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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