Dynamic Portfolio Selection by Augmenting the Asset Space

38 Pages Posted: 7 Mar 2004

See all articles by Michael W. Brandt

Michael W. Brandt

Duke University - Fuqua School of Business; National Bureau of Economic Research (NBER)

Pedro Santa-Clara

New University of Lisbon - Nova School of Business and Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

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Date Written: March 5, 2004

Abstract

We present a novel approach to dynamic portfolio selection that is no more difficult to implement than the static Markowitz model. The idea is to expand the asset space to include simple (mechanically) managed portfolios and compute the optimal static portfolio in this extended asset space. The intuition is that a static choice among managed portfolios is equivalent to a dynamic strategy. We consider managed portfolios of two types: "conditional" and "timing" portfolios. Conditional portfolios are constructed along the lines of Hansen and Richard (1987). For each variable that affects the distribution of returns and for each basis asset, we include a portfolio that invests in the basis asset an amount proportional to the level of the conditioning variable. Timing portfolios invest in each basis asset for a single period and therefore mimic strategies that buy and sell the asset through time. We apply our method to a problem of dynamic asset allocation across stocks, bonds, and cash using the predictive ability of four conditioning variables.

Keywords: Dynamic portfolio choice, asset allocation, mean variance, Markowitz

JEL Classification: G0, G11

Suggested Citation

Brandt, Michael W. and Santa-Clara, Pedro, Dynamic Portfolio Selection by Augmenting the Asset Space (March 5, 2004). AFA 2005 Philadelphia Meetings. Available at SSRN: https://ssrn.com/abstract=514582 or http://dx.doi.org/10.2139/ssrn.514582

Michael W. Brandt (Contact Author)

Duke University - Fuqua School of Business ( email )

1 Towerview Drive
Durham, NC 27708-0120
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Pedro Santa-Clara

New University of Lisbon - Nova School of Business and Economics ( email )

Lisbon
Portugal

HOME PAGE: http://docentes.fe.unl.pt/~psc/

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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