Investing for the Long Run
38 Pages Posted: 11 May 2017 Last revised: 29 Mar 2019
Date Written: May 29, 2018
A major problem in financial engineering is investing on financial markets for long horizons. At infinite horizons, dynamic versions of the Kelly strategy are mathematically certain to maximize growth, such that these growth-optimal portfolios outperform all other investment strategies. This paper studies investing under finite but long horizons. We define a generalized form of stochastic discount factor (SDF), draw attention to the importance that it is tradeable, and to the related minimum price to generate a target payoff by investing. This leads us to the tradeable SDF that is the inverse of the growth-optimal portfolio. We then show that long-run optimal wealth evolution is closely linked to dynamic versions of Kelly strategies. Finally, we illustrate that our new framework leads to improved risk-return tradeoffs in long-term investments.
Keywords: stochastic discount factor, minimum pricing, optimal portfolio, growth optimal portfolio, dynamic Kelly strategy
JEL Classification: G11, G13
Suggested Citation: Suggested Citation