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

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  • Tom Engsted
  • Thomas Q. Pedersen

    ()
    (School of Economics and Management, University of Aarhus, Denmark and CREATES)

Abstract

We extend the VAR based intertemporal asset allocation approach from Campbell et al. (2003) to the case where the VAR parameter estimates are adjusted for small- sample bias. We apply the analytical bias formula from Pope (1990) using both Campbell et al.'s dataset, and an extended dataset with quarterly data from 1952 to 2006. The results show that correcting the VAR parameters for small-sample bias has both quantitatively and qualitatively important e¤ects on the strategic intertemporal part of optimal portfolio choice, especially for bonds: for intermediate values of risk-aversion, the intertemporal hedging demand for bonds - and thereby the total demand for bonds - is strongly reduced by the bias-adjustment. We also investigate the robustness of the results by changing the lag-length and one of the state variables of the VAR.

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Bibliographic Info

Paper provided by School of Economics and Management, University of Aarhus in its series CREATES Research Papers with number 2008-27.

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Length: 37
Date of creation: 28 May 2008
Date of revision:
Handle: RePEc:aah:create:2008-27

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Web page: http://www.econ.au.dk/afn/

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Keywords: Intertemporal portfolio choice; return predictability; VAR model; small-sample bias;

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References

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Citations

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Cited by:
  1. 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.
  2. Thomas Q. Pedersen, 2010. "Predictable return distributions," CREATES Research Papers 2010-38, 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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