Nonmyopic Optimal Portfolios in Viable Markets
55 Pages Posted: 20 Oct 2010
Date Written: October 9, 2010
Abstract
We provide a representation for the nonmyopic optimal portfolio of an agent consuming only at the terminal horizon when the single state variable follows a general diusion process and the market consists of one risky asset and a risk-free asset. The key term of our representation is a new object that we call the "rate of macroeconomic fluctuation" whose properties are fundamental for the portfolio dynamics. We show that, under natural cyclicality conditions, (i) the agent's hedging demand is positive (negative) when the product of his prudence and risk tolerance is below (above) 2 and (ii) the portfolio weights decrease in risk aversion. We apply our results to study a general continuous-time capital asset pricing model and show that under the same cyclicality conditions, the market price of risk is countercyclical and the price of the risky asset exhibits excess volatility.
Keywords: Heterogeneous Agents, Nonmyopic Optimal Portfolios, Hedging Demand, Equilibrium
JEL Classification: D53, G11, G12
Suggested Citation: Suggested Citation
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