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Momentum in strategic asset allocation

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Listed:
  • Wu, Hui
  • Ma, Chaoqun
  • Yue, Shengjie

Abstract

This paper explores a continuous-time intertemporal consumption and portfolio choice problem for an infinite horizon investor with recursive utility defined over consumption. The investor who tries to exploit momentum is assumed to have access to a risk-free asset and a risky asset whose return exhibits short run momentum. We derive an exact explicit solution and an approximate analytical solution to the dynamic asset allocation problem. We find that the optimal portfolio demand for stocks contains two components: the “momentum-adjusted” myopic demand and the intertemporal hedging demand. When the model is calibrated to Chinese stock market data, it implies that intertemporal hedging demand motives greatly decrease the portfolio demand for stocks by investors whose risk aversion coefficients exceed one when the latest levels of stock returns are non-negative or moderate negative. In addition, hedging motives increase the optimal portfolio when they are sufficiently negative. Also, we find that risk aversion is the main preference parameter in determining portfolio choice rather than the elasticity of intertemporal substitution.

Suggested Citation

  • Wu, Hui & Ma, Chaoqun & Yue, Shengjie, 2017. "Momentum in strategic asset allocation," International Review of Economics & Finance, Elsevier, vol. 47(C), pages 115-127.
  • Handle: RePEc:eee:reveco:v:47:y:2017:i:c:p:115-127
    DOI: 10.1016/j.iref.2016.10.009
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    References listed on IDEAS

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    Keywords

    Momentum; Strategic asset allocation; Intertemporal hedging demand; Recursive utility;

    JEL classification:

    • 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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