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Portfolio Choice under Inflation: Are Popular Recommendations Consistent with Rational Behavior?

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Author Info
Munk, Claus (University of Southern Denmark)
Sørensen, Carsten (Department of Finance, Copenhagen Business School)
Vinther, Tina Nygaard (SimCorp Danmark A/S)
Abstract

We consider the optimal asset allocation choice of an investor who can invest in

cash (a money market bank account), nominal bonds, and stocks (the stock index).

The investor faces an incomplete market setting and is not able to perfectly hedge

long run real interest rate risk using the available securities. The optimal invest-

ment strategy is consistent with the following features of popular investment advice

which have been pointed out as puzzles: (i) a decreasing fraction of stocks in the

portfolio as time passes towards the investment horizon, and (ii) a higher bond to

stock ratio for more conservative (less risk tolerant) investors (Canner, Mankiw and

Weil, 1997). The model for asset price dynamics is calibrated to US market data

and, furthermore, risk aversion parameters and time horizons are calibrated so as

to obtain a match between the optimal asset allocations and observed investment

recommendations for \aggressive," \moderate," and \conservative" investor groups

with di®erent investment horizons.

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Publisher Info
Paper provided by Copenhagen Business School, Department of Finance in its series Working Papers with number 2001-6.

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Length: 23 pages
Date of creation: 01 Dec 2001
Date of revision:
Handle: RePEc:hhs:cbsfin:2001_006

Contact details of provider:
Postal: Department of Finance, Copenhagen Business School, Solbjerg Plads 3, A5, DK-2000 Frederiksberg, Denmark
Phone: +45 3815 3815
Email:
Web page: http://www.cbs.dk/departments/finance/
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Related research
Keywords: Investment; Nominal bonds; Stocks; Market setting; Securities; Investment strategy; Risk;

Find related papers by JEL classification:
G00 - Financial Economics - - General - - - General
G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
G30 - Financial Economics - - Corporate Finance and Governance - - - General

This paper has been announced in the following NEP Reports:

References listed on IDEAS
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  1. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1979. "Duration and the Measurement of Basis Risk," Journal of Business, University of Chicago Press, vol. 52(1), pages 51-61, January. [Downloadable!] (restricted)
  2. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-87, September. [Downloadable!] (restricted)
  3. Elton, Edwin J. & Gruber, Martin J., 2000. "The Rationality of Asset Allocation Recommendations," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 35(01), pages 27-41, March. [Downloadable!]
  4. Breeden, Douglas T., 1986. "Consumption, production, inflation and interest rates : A synthesis," Journal of Financial Economics, Elsevier, vol. 16(1), pages 3-39, May. [Downloadable!] (restricted)
  5. Canner, Niko & Mankiw, N Gregory & Weil, David N, 1997. "An Asset Allocation Puzzle," American Economic Review, American Economic Association, vol. 87(1), pages 181-91, March. [Downloadable!] (restricted)
    Other versions:
  6. Ingersoll, Jonathan E. & Skelton, Jeffrey & Weil, Roman L., 1978. "Duration Forty Years Later," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 13(04), pages 627-650, November. [Downloadable!]
  7. Pennacchi, George G, 1991. "Identifying the Dynamics of Real Interest Rates and Inflation: Evidence Using Survey Data," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 4(1), pages 53-86. [Downloadable!] (restricted)
  8. John Y. Campbell & Luis M. Viceira, 2001. "Who Should Buy Long-Term Bonds?," American Economic Review, American Economic Association, vol. 91(1), pages 99-127, March. [Downloadable!] (restricted)
    Other versions:
  9. Cox, John C. & Huang, Chi-fu, 1991. "A variational problem arising in financial economics," Journal of Mathematical Economics, Elsevier, vol. 20(5), pages 465-487. [Downloadable!] (restricted)
  10. Merton, Robert C., 1971. "Optimum consumption and portfolio rules in a continuous-time model," Journal of Economic Theory, Elsevier, vol. 3(4), pages 373-413, December. [Downloadable!] (restricted)
    Other versions:
  11. Merton, Robert C, 1969. "Lifetime Portfolio Selection under Uncertainty: The Continuous-Time Case," The Review of Economics and Statistics, MIT Press, vol. 51(3), pages 247-57, August. [Downloadable!] (restricted)
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