Dynamic Asset Allocation: Portfolio Decomposition Formula and Applications

Posted: 25 Jan 2010

See all articles by Jerome Detemple

Jerome Detemple

Boston University - Department of Finance & Economics; Center for Interuniversity Research and Analysis on Organization (CIRANO)

Date Written: June 2009

Abstract

A new decomposition of the optimal portfolio, in dynamic models with von Neumann-Morgenstern preferences and Ito prices, is established. The formula rests on a change of numéraire that uses pure discount bonds as units of account. The dynamic hedging demand has two components. The first hedge insures against fluctuations in an optimally designed bond with a maturity date matching the investor's horizon. The second hedge immunizes against fluctuations in the market price of risk in the bond numéraire. Various applications are examined. New results concerning the behavior of extremely risk-averse individuals, the demand for bonds and its long-horizon limit, and the optimal portfolio in incomplete markets are derived.

Keywords: G11

Suggested Citation

Detemple, Jerome, Dynamic Asset Allocation: Portfolio Decomposition Formula and Applications (June 2009). The Review of Financial Studies, Vol. 23, Issue 1, pp. 25-100, 2009. Available at SSRN: https://ssrn.com/abstract=1541001 or http://dx.doi.org/hhp040

Jerome Detemple (Contact Author)

Boston University - Department of Finance & Economics ( email )

595 Commonwealth Avenue
Boston, MA 02215
United States
(617) 353-4297 (Phone)
(617) 353 6667 (Fax)

Center for Interuniversity Research and Analysis on Organization (CIRANO)

2020 rue University, 25th Floor
Montreal, Quebec H3C 3J7
Canada

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