Strategic Asset Allocation: Portfolio Choice for Long-Term Investors
Academic finance has had a remarkable impact on many financial services. Yet long-term investors have received curiously little guidance from academic financial economists. Mean-variance analysis, developed almost fifty years ago, has provided a basic paradigm for portfolio choice. This approach usefully emphasizes the ability of diversification to reduce risk, but it ignores several critically important factors. Most notably, the analysis is static; it assumes that investors care only about risks to wealth one period ahead. However, many investors—-both individuals and institutions such as charitable foundations or universities—-seek to finance a stream of consumption over a long lifetime. In addition, mean-variance analysis treats financial wealth in isolation from income. Long-term investors typically receive a stream of income and use it, along with financial wealth, to support their consumption. At the theoretical level, it is well understood that the solution to a long-term portfolio choice problem can be very different from the solution to a short-term problem. Long-term investors care about intertemporal shocks to investment opportunities and labor income as well as shocks to wealth itself, and they may use financial assets to hedge their intertemporal risks. This should be important in practice because there is a great deal of empirical evidence that investment opportunities—-both interest rates and risk premia on bonds and stocks—-vary through time. Yet this insight has had little influence on investment practice because it is hard to solve for optimal portfolios in intertemporal models. This book seeks to develop the intertemporal approach into an empirical paradigm that can compete with the standard mean-variance analysis. The book shows that long-term inflation-indexed bonds are the riskless asset for long-term investors, it explains the conditions under which stocks are safer assets for long-term than for short-term investors, and it shows how labor income influences portfolio choice. These results shed new light on the rules of thumb used by financial planners. The book explains recent advances in both analytical and numerical methods, and shows how they can be used to understand the portfolio choice problems of long-term investors.
What people are saying - Write a review
We haven't found any reviews in the usual places.
Other editions - View all
analysis asset allocation Asset Pricing assume assumption Bellman equation bond returns budget constraint Campbell and Viceira Chapter conservative investors constant consumption and portfolio consumption–wealth ratio continuous-time correlated covariance dynamic effects elasticity of intertemporal equity premium equity premium puzzle estimates Euler equation excess returns excess stock returns expected returns financial assets Financial Economics financial wealth hold horizon effects households human wealth implies increases indexed bonds inflation risk inflation-indexed bonds intertemporal hedging demand intertemporal substitution investment horizon investment opportunities Journal of Financial labor income risk log return lognormal long-term bonds long-term investors mean mean-reverting negative nominal bonds optimal consumption parameter period portfolio choice portfolio return portfolio rule power utility precautionary savings problem real interest rate relative risk aversion risk premia risk premium riskless asset risky asset return Section Sharpe ratio standard deviation stock market subsistence level term structure time-varying utility function value function variables variance vector volatility