Nonmyopic Optimal Portfolios in Viable Markets

55 Pages Posted: 20 Oct 2010

See all articles by Jaksa Cvitanic

Jaksa Cvitanic

California Institute of Technology - Division of the Humanities and Social Sciences

Semyon Malamud

Ecole Polytechnique Federale de Lausanne; Centre for Economic Policy Research (CEPR); Swiss Finance Institute

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 di usion 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

Cvitanic, Jaksa and Malamud, Semyon, Nonmyopic Optimal Portfolios in Viable Markets (October 9, 2010). Swiss Finance Institute Research Paper No. 10-42, Available at SSRN: https://ssrn.com/abstract=1694576 or http://dx.doi.org/10.2139/ssrn.1694576

Jaksa Cvitanic

California Institute of Technology - Division of the Humanities and Social Sciences ( email )

1200 East California Blvd.
Pasadena, CA 91125
United States

HOME PAGE: http://www.hss.caltech.edu/~cvitanic/

Semyon Malamud (Contact Author)

Ecole Polytechnique Federale de Lausanne ( email )

Lausanne, 1015
Switzerland

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

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