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Momentum and Mean-Reversion in Strategic Asset AllocationRalph S. J. KoijenUniversity of Chicago - Booth School of Business Juan Carlos RodriguezTilburg University and CentER Alessandro SbuelzCatholic University of Milan - Department of Mathematics, Quantitative Finance, and Econometrics; Bocconi University - CAREFIN - Centre for Applied Research in Finance January 27, 2009 EFA 2006 Zurich Meetings Abstract: We study a dynamic asset allocation problem in which stock returns exhibit short-run momentum and long-run mean reversion. We develop a tractable continuous-time model that captures these two predictability features and derive the optimal investment strategy in closed-form. The model predicts negative hedging demands for medium-term investors, and an allocation to stocks that is non-monotonic in the investor's horizon. Momentum substantially increases the economic value of hedging time-variation in investment opportunities. These utility gains are preserved when we impose realistic borrowing and short-sales constraints and allow the investor to trade on a monthly frequency.
Number of Pages in PDF File: 34 Keywords: Return predictability, Momentum, Mean reversion, Portfolio choice JEL Classification: G0, G11, G12 working papers seriesDate posted: June 7, 2006 ; Last revised: January 28, 2009Suggested CitationContact Information
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