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Strategic Asset Allocation in a Continuous-Time VAR Model

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  • John Y. Campbell
  • George Chacko
  • Jorge Rodriguez
  • Luis M. Viciera

Abstract

This note derives an approximate solution to a continuous-time intertemporal portfolio and consumption choice problem. The problem is the continuous-time equivalent of the discrete-time problem studied by Campbell and Viceira (1999), in which the expected excess return on a risky asset follows an AR(1)process, while the riskless interest rate is constant. The note also shows how to obtain continuous-time parameters that are consistent with discrete-time econometric estimates. The continuous-time solution is numerically close to that of Campbell and Viceira and has the property that conservative long-term investors have a large positive intertemporal hedging demand for stocks.

Suggested Citation

  • John Y. Campbell & George Chacko & Jorge Rodriguez & Luis M. Viciera, 2003. "Strategic Asset Allocation in a Continuous-Time VAR Model," NBER Working Papers 9547, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:9547
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    References listed on IDEAS

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    1. John Y. Campbell & Yeung Lewis Chanb & M. Viceira, 2013. "A multivariate model of strategic asset allocation," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part II, chapter 39, pages 809-848, World Scientific Publishing Co. Pte. Ltd..
    2. George Chacko & Luis M. Viceira, 2005. "Dynamic Consumption and Portfolio Choice with Stochastic Volatility in Incomplete Markets," The Review of Financial Studies, Society for Financial Studies, vol. 18(4), pages 1369-1402.
    3. Larry G. Epstein & Stanley E. Zin, 2013. "Substitution, risk aversion and the temporal behavior of consumption and asset returns: A theoretical framework," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part I, chapter 12, pages 207-239, World Scientific Publishing Co. Pte. Ltd..
    4. 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.
    5. Duffie, Darrell & Epstein, Larry G, 1992. "Stochastic Differential Utility," Econometrica, Econometric Society, vol. 60(2), pages 353-394, March.
    6. Epstein, Larry G & Zin, Stanley E, 1991. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: An Empirical Analysis," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 263-286, April.
    7. Wachter, Jessica A., 2002. "Portfolio and Consumption Decisions under Mean-Reverting Returns: An Exact Solution for Complete Markets," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 37(1), pages 63-91, March.
    8. LuisM. Viceira & John Y. Campbell, 2001. "Who Should Buy Long-Term Bonds?," American Economic Review, American Economic Association, vol. 91(1), pages 99-127, March.
    9. John Y. Campbell & Albert S. Kyle, 1993. "Smart Money, Noise Trading and Stock Price Behaviour," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 60(1), pages 1-34.
    10. Campbell, John Y. & Viceira, Luis M., 2002. "Strategic Asset Allocation: Portfolio Choice for Long-Term Investors," OUP Catalogue, Oxford University Press, number 9780198296942.
    11. Kim, Tong Suk & Omberg, Edward, 1996. "Dynamic Nonmyopic Portfolio Behavior," The Review of Financial Studies, Society for Financial Studies, vol. 9(1), pages 141-161.
    12. Bergstrom, A.R., 1984. "Continuous time stochastic models and issues of aggregation over time," Handbook of Econometrics, in: Z. Griliches† & M. D. Intriligator (ed.), Handbook of Econometrics, edition 1, volume 2, chapter 20, pages 1145-1212, Elsevier.
    13. Duffie, Darrel & Lions, Pierre-Louis, 1992. "PDE solutions of stochastic differential utility," Journal of Mathematical Economics, Elsevier, vol. 21(6), pages 577-606.
    14. John Y. Campbell & Luis M. Viceira, 1999. "Consumption and Portfolio Decisions when Expected Returns are Time Varying," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 114(2), pages 433-495.
    15. Duffie, Darrell & Epstein, Larry G, 1992. "Asset Pricing with Stochastic Differential Utility," The Review of Financial Studies, Society for Financial Studies, vol. 5(3), pages 411-436.
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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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