Momentum and Mean-Reversion in Strategic Asset Allocation
Ralph S. J. Koijen
University of Chicago - Booth School of Business
Juan Carlos Rodriguez
Tilburg University and CentER
Catholic 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
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, G12working papers series
Date posted: June 7, 2006 ; Last revised: January 28, 2009
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