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

Posted: 10 Apr 2002

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)

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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 restrictions. These constraints bind when the equity premium moves away from its mean in either direction, and are particularly severe for risk-tolerant investors. The constraints have substantial effects on optimal consumption, but much more modest effects on optimal portfolio choice in the region of the state space where they are not binding.

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. European Finance Review, Vol. 5, No. 3. Available at SSRN: https://ssrn.com/abstract=305685

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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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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