A Multivariate Model of Strategic Asset Allocation
John Y. Campbell
Harvard University - Department of Economics; National Bureau of Economic Research (NBER)
Yeung Lewis Chan
Hong Kong University of Science & Technology (HKUST) - Department of Finance
Luis M. Viceira
Harvard Business School - Finance Unit; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)
NBER Working Paper No. w8566
Much recent work has documented evidence for predictability of asset returns. We show how such predictability can affect the portfolio choices of long-lived investors who value wealth not for its own sake but for the consumption their wealth can support. We develop an approximate solution method for the optimal consumption and portfolio choice problem of an infinitely-lived investor with Epstein-Zin utility who faces a set of asset returns described by a vector autoregression in returns and state variables. Empirical estimates in long-run annual and postwar quarterly US data suggest that the predictability of stock returns greatly increases the optimal demand for stocks. The role of nominal bonds in long-term portfolios depends on the importance of real interest rate risk relative to other sources of risk. We extend the analysis to consider long-term inflation-indexed bonds and find that these bonds greatly increase the utility of conservative investors, who should hold large positions when they are available.
Number of Pages in PDF File: 79working papers series
Date posted: October 25, 2001
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