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Strategic Asset Allocation for Long-Term Investors: Parameter Uncertainty and Prior Information

51 Pages Posted: 22 Apr 2011  

Roy P. M. M. Hoevenaars

APG Asset Management

Roderick Molenaar

Robeco Asset Management

Peter C. Schotman

Maastricht University - Limburg Institute of Financial Economics (LIFE)

Tom Steenkamp

ABP Investments - Research Department

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Date Written: April 4, 2011

Abstract

We study the effect of parameter uncertainty on the long-run risk of three alternative asset classes: equity, nominal bonds and short-term T-Bills. We estimate the long-run risk as the annualized predictive variance of returns at different horizons implied by a vector autoregression using alternative Bayesian priors. Under an uninformative prior we conclude that not only equity becomes more risky relative to estimates that are conditional on known parameter values. The long-run risk of long and short-term bonds increases proportionally with the same factor. Correlations among returns appear robust against parameter uncertainty. Alternative informative priors imply large differences in expected returns, which lead to different optimal portfolios. To limit the effect of a single prior we derive a robust portfolio rule that associates a portfolio with the worst prior for that portfolio. The optimal robust portfolio appears well-diversified and stable with respect to the investment horizon.

Keywords: strategic asset allocation, Bayesian vector autoregression, parameter uncertainty, robust portfolio choice

JEL Classification: C32, G11, C11

Suggested Citation

Hoevenaars, Roy P. M. M. and Molenaar, Roderick and Schotman, Peter C. and Steenkamp, Tom, Strategic Asset Allocation for Long-Term Investors: Parameter Uncertainty and Prior Information (April 4, 2011). Netspar Discussion Paper No. 04/2011-038. Available at SSRN: https://ssrn.com/abstract=1816443 or http://dx.doi.org/10.2139/ssrn.1816443

Roy P. M. M. Hoevenaars

APG Asset Management ( email )

P.O. Box 75283
1070 AG
Amsterdam
Netherlands
+31206048313 (Phone)

Roderick Molenaar

Robeco Asset Management ( email )

Weena 850
Rotterdam, 3014 DA
Netherlands

Peter C. Schotman (Contact Author)

Maastricht University - Limburg Institute of Financial Economics (LIFE) ( email )

P.O. Box 616
Maastricht, 6200 MD
Netherlands
+31 43 388 3862 (Phone)
+31 43 388 4875 (Fax)

Tom Steenkamp

ABP Investments - Research Department ( email )

WTC Schiphol Airport
Tower C, 5th Floor P.O. Box 75753
Schiphol NL-1118 ZX
Netherlands

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