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Optimal allocation of government bond funds through the business cycle. Is money smart?

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  • Laborda, Ricardo
  • Muñoz, Fernando

Abstract

We characterize the optimal portfolio decision of an investor who maximizes the conditional expected utility of the return on his or her portfolio, given an investment opportunity set consisting of a U.S. sovereign bond mutual fund and its benchmark. Our results show that, on average, the investor should overweight U.S. government bond funds during recession periods when the “level” factor of interest and the output gap are low and the “curvature” factor of the U.S. yield curve, investor sentiment and the VIX are high, these being related to high U.S. bond risk premia. Important differences in optimal portfolio performance measures across bond fund managers through the business cycle have a great impact on the investor's welfare. However, we find almost no evidence that funds that receive more money subsequently beat the market.

Suggested Citation

  • Laborda, Ricardo & Muñoz, Fernando, 2016. "Optimal allocation of government bond funds through the business cycle. Is money smart?," International Review of Economics & Finance, Elsevier, vol. 45(C), pages 46-67.
    • Handle: RePEc:eee:reveco:v:45:y:2016:i:c:p:46-67
    DOI: 10.1016/j.iref.2016.04.008
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    Cited by:

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    2. Beladi, Hamid & Chao, Chi Chur & Hu, May, 2016. "A macro-analysis of financial decisions: An examination of special dividend announcements," International Review of Financial Analysis, Elsevier, vol. 48(C), pages 162-181.
    3. Dutra, Tiago Mota & Dias, José Carlos & Teixeira, João C.A., 2022. "Measuring financial cycles: Empirical evidence for Germany, United Kingdom and United States of America," International Review of Economics & Finance, Elsevier, vol. 79(C), pages 599-630.

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    More about this item

    Keywords

    Portfolio choice; U.S. government bond fund; State variables; Recession; Smart money;
    All these keywords.

    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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