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Dynamic Mean-Variance Asset Allocation

Listed author(s):
  • Suleyman Basak
  • Georgy Chabakauri

We solve the dynamic mean-variance portfolio problem and derive its time-consistent solution using dynamic programming. Previous literature, in contrast, only determines either myopic or precommitment (committing to follow the initially optimal policy) solutions. We provide a fully analytical simple characterization of the dynamically optimal mean-variance portfolios within a general incomplete-market economy. We also identify a probability measure that incorporates intertemporal hedging demands and facilitates tractability. We illustrate this by easily computing portfolios explicitly under various stochastic investment opportunities. A calibration exercise shows that the mean-variance hedging demands are economically significant. The Author 2010. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org., Oxford University Press.

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File URL: http://hdl.handle.net/10.1093/rfs/hhq028
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Article provided by Society for Financial Studies in its journal The Review of Financial Studies.

Volume (Year): 23 (2010)
Issue (Month): 8 (August)
Pages: 2970-3016

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Handle: RePEc:oup:rfinst:v:23:y:2010:i:8:p:2970-3016
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