Dynamic Asset Allocation with Regime Shifts and Long Horizon CVaR-Constraints

Abstract

We analyze portfolio policies for investors who invest optimally for given investment horizons with respect to Conditional Value-at-Risk constraints. We account for non-normally distributed, skewed, and leptokurtic asset return distribution due to regime shifts. The focus is on standard CRRA utility with a money back guarantee at maturity, which is often embedded in individual retirement plans. Optimal solutions for the unconstrained as well as the constrained policy are provided and examined for risk management costs calculated as welfare losses. Our results confirm previous findings that money back guarantees yield mild downside protection at low economic costs for most long term investors.

Keywords: term structure models, downside risk constraints

JEL Classification: G11