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Consumption And Portfolio Decisions When Expected Returns Are Time Varying

  • John Y. Campbell
  • Luis M. Viceira

This paper presents an approximate analytical solution to the optimal consumption and portfolio choice problem of an infinitely lived investor with Epstein-Zin-Weil utility who faces a constant riskless interest rate and a time-varying equity premium. When the model is calibrated to U. S. stock market data, it implies that intertemporal hedging motives greatly increase, and may even double, the average demand for stocks by investors whose risk-aversion coefficients exceed one. The optimal portfolio policy also involves timing the stock market. Failure to time or to hedge can cause large welfare losses relative to the optimal policy. © 2000 the President and Fellows of Harvard College and the Massachusetts Institute of Technology

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Article provided by MIT Press in its journal The Quarterly Journal of Economics.

Volume (Year): 114 (1999)
Issue (Month): 2 (May)
Pages: 433-495

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Handle: RePEc:tpr:qjecon:v:114:y:1999:i:2:p:433-495
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  1. John Y. Campbell & Luis M. Viceira, 1998. "Who Should Buy Long-Term Bonds?," NBER Working Papers 6801, National Bureau of Economic Research, Inc.
  2. Campbell, John & Viceira, Luis, 1999. "Consumption and Portfolio Decisions When Expected Returns are Time Varying," Scholarly Articles 3163266, Harvard University Department of Economics.
  3. Weil, Philippe, 1989. "The equity premium puzzle and the risk-free rate puzzle," Journal of Monetary Economics, Elsevier, vol. 24(3), pages 401-421, November.
  4. Fama, Eugene F. & French, Kenneth R., 1988. "Dividend yields and expected stock returns," Journal of Financial Economics, Elsevier, vol. 22(1), pages 3-25, October.
  5. Campbell, John Y., 1987. "Stock returns and the term structure," Journal of Financial Economics, Elsevier, vol. 18(2), pages 373-399, June.
  6. Brennan, Michael J. & Schwartz, Eduardo S. & Lagnado, Ronald, 1997. "Strategic asset allocation," Journal of Economic Dynamics and Control, Elsevier, vol. 21(8-9), pages 1377-1403, June.
  7. Alberto Giovannini & Philippe Weil, 1989. "Risk Aversion and Intertemporal Substitution in the Capital Asset Pricing Model," NBER Working Papers 2824, National Bureau of Economic Research, Inc.
  8. Cox, John C. & Huang, Chi-fu, 1989. "Optimal consumption and portfolio policies when asset prices follow a diffusion process," Journal of Economic Theory, Elsevier, vol. 49(1), pages 33-83, October.
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