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Dynamic asset allocation and latent variables

  • Sørensen, Carsten

    (Department of Finance, Copenhagen Business School)

  • Trolle, Anders Bjerre

    (Department of Finance, Copenhagen Business School)

Registered author(s):

    We derive an explicit solution to the portfolio problem of a power utility investor with preferences for wealth at a ¯nite investment horizon. The investor can invest in assets with return dynamics described as part of a general multivariate model. The modeling framework encompasses discrete-time VAR-models where some of the state-variables (e.g. expected excess returns) may not be directly observable. A realistic multivariate model is estimated and applied to analyze the portfolio implications of investment horizon and return predictability when real interest rates and expected excess returns on stock and bonds are not directly observed but must be estimated as part of the problem faced by the investor. The solution exhibits small variability in portfolio allocations over time compared to the case when excess returns are assumed observable.

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    File URL: http://openarchive.cbs.dk/cbsweb/handle/10398/7151
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    Paper provided by Copenhagen Business School, Department of Finance in its series Working Papers with number 2004-8.

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    Length: 55 pages
    Date of creation: 26 Jun 2006
    Date of revision:
    Handle: RePEc:hhs:cbsfin:2004_008
    Contact details of provider: Postal: Department of Finance, Copenhagen Business School, Solbjerg Plads 3, A5, DK-2000 Frederiksberg, Denmark
    Phone: +45 3815 3815
    Web page: http://www.cbs.dk/departments/finance/
    Email:


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