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Momentum and Mean-Reversion in Strategic Asset Allocation

34 Pages Posted: 7 Jun 2006 Last revised: 28 Jan 2009

Ralph S. J. Koijen

New York University (NYU) - Department of Finance; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Juan Carlos Rodriguez

Tilburg University and CentER

Alessandro Sbuelz

Catholic University of Milan - Department of Mathematics, Quantitative Finance, and Econometrics; Bocconi University - CAREFIN - Centre for Applied Research in Finance

Date Written: January 27, 2009

Abstract

We study a dynamic asset allocation problem in which stock returns exhibit short-run momentum and long-run mean reversion. We develop a tractable continuous-time model that captures these two predictability features and derive the optimal investment strategy in closed-form. The model predicts negative hedging demands for medium-term investors, and an allocation to stocks that is non-monotonic in the investor's horizon. Momentum substantially increases the economic value of hedging time-variation in investment opportunities. These utility gains are preserved when we impose realistic borrowing and short-sales constraints and allow the investor to trade on a monthly frequency.

Keywords: Return predictability, Momentum, Mean reversion, Portfolio choice

JEL Classification: G0, G11, G12

Suggested Citation

Koijen, Ralph S. J. and Rodriguez, Juan Carlos and Sbuelz, Alessandro, Momentum and Mean-Reversion in Strategic Asset Allocation (January 27, 2009). EFA 2006 Zurich Meetings. Available at SSRN: https://ssrn.com/abstract=687205 or http://dx.doi.org/10.2139/ssrn.687205

Ralph S. J. Koijen (Contact Author)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

HOME PAGE: http://www.koijen.net

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Juan Carlos Rodriguez

Tilburg University and CentER ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 466 3262 (Phone)
+31 13 466 2875 (Fax)

Alessandro Sbuelz

Catholic University of Milan - Department of Mathematics, Quantitative Finance, and Econometrics ( email )

largo A. Gemelli 1
I-20123 Milan
Italy
+39 02 7234 2345 (Phone)
+39 02 7234 2671 (Fax)

HOME PAGE: http://ppd.unicatt.it/docenti/alessandro_sbuelz

Bocconi University - CAREFIN - Centre for Applied Research in Finance

Via Sarfatti, 25
Milan, 20136
Italy

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