The Costs of Suboptimal Dynamic Asset Allocation: General Results and Applications to Interest Rate Risk, Stock Volatility Risk, and Growth/Value Tilts

62 Pages Posted: 19 Feb 2009 Last revised: 8 Apr 2011

See all articles by Linda Sandris Larsen

Linda Sandris Larsen

Copenhagen Business School

Claus Munk

Copenhagen Business School

Date Written: April 6, 2011

Abstract

The recent theoretical asset allocation literature has derived optimal dynamic investment strategies in various advanced models of asset returns. But how sensitive is investor welfare to deviations from the theoretically optimal strategy? Will unsophisticated investors do almost as well as sophisticated investors? This paper develops a general theoretical framework for answering such questions and applies it to three specific models of interest rate risk, stochastic stock volatility, and mean reversion and growth/value tilts of stock portfolios. Among other things, we find that growth/value tilts are highly valuable, but the hedging of time-varying stock risk premia is less important.

Keywords: Suboptimal investments, wealth-equivalent utility loss, stochastic interest rates, stochastic volatility, growth and value stocks, mean reversion in stock returns

JEL Classification: G11

Suggested Citation

Larsen, Linda Sandris and Munk, Claus, The Costs of Suboptimal Dynamic Asset Allocation: General Results and Applications to Interest Rate Risk, Stock Volatility Risk, and Growth/Value Tilts (April 6, 2011). Available at SSRN: https://ssrn.com/abstract=1338074 or http://dx.doi.org/10.2139/ssrn.1338074

Linda Sandris Larsen

Copenhagen Business School ( email )

Solbjerg Plads 3, A5
Frederiksberg, 2000
Denmark

Claus Munk (Contact Author)

Copenhagen Business School ( email )

Department of Finance
Solbjerg Plads 3
Frederiksberg, DK-2000
Denmark

HOME PAGE: http://sites.google.com/view/clausmunk/home

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
273
Abstract Views
1,049
rank
121,337
PlumX Metrics