Dynamic Portfolio Selection by Augmenting the Asset Space

39 Pages Posted: 30 Mar 2004

See all articles by Pedro Santa-Clara

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)

Michael W. Brandt

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

Multiple version iconThere are 2 versions of this paper

Date Written: March 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.

Suggested Citation

Santa-Clara, Pedro and Brandt, Michael W., Dynamic Portfolio Selection by Augmenting the Asset Space (March 2004). NBER Working Paper No. w10372. Available at SSRN: https://ssrn.com/abstract=520665

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)

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Cambridge, MA 02138
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Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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

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