Stock Market Mean Reversion and the Optimal Equity Allocation of a Long-Lived Investor

28 Pages Posted: 1 Aug 2000

See all articles by John Y. Campbell

John Y. Campbell

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Joao F. Cocco

London Business School; Centre for Economic Policy Research (CEPR)

Francisco Gomes

London Business School

Pascal J. Maenhout

INSEAD - Finance

Luis M. Viceira

Harvard Business School - Finance Unit; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: June 2000

Abstract

This paper solves numerically the intertemporal consumption and portfolio choice problem of an infinitely-lived investor who faces a time-varying equity premium. The solutions we obtain are very similar to the approximate analytical solutions of Campbell and Viceira (1999), except at the upper extreme of the state space where both the numerical consumption and portfolio rules flatten out. We also consider a constrained version of the problem in which the investor faces borrowing and short-sales constraints. These constraints bind when the equity premium moves away from its mean in either direction, and are particularly severe for risk-tolerant investors. The optimal constrained portfolio rules are similar but not identical to the optimal unconstrained rules with the constraints imposed. The portfolio constraints also affect the optimal consumption policy.

Keywords: Hedging Demand, Intertemporal Portfolio Choice, And Mean Reversion

JEL Classification: G12

Suggested Citation

Campbell, John Y. and Cocco, João F. and Gomes, Francisco and Maenhout, Pascal J. and Viceira, Luis M., Stock Market Mean Reversion and the Optimal Equity Allocation of a Long-Lived Investor (June 2000). Harvard Institute of Economic Research Paper No. 1899. Available at SSRN: https://ssrn.com/abstract=237175 or http://dx.doi.org/10.2139/ssrn.237175

John Y. Campbell (Contact Author)

Harvard University - Department of Economics ( email )

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João F. Cocco

London Business School ( email )

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Centre for Economic Policy Research (CEPR)

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Francisco Gomes

London Business School ( email )

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Pascal J. Maenhout

INSEAD - Finance ( email )

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Luis M. Viceira

Harvard Business School - Finance Unit ( email )

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HOME PAGE: http://www.people.hbs.edu/lviceira

National Bureau of Economic Research (NBER)

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