Strategic Asset Allocation Portfolio Choice for Long-Term Investors

by Campbell, John Y.; Viceira, Luis M.

• ISBN13: 9780198296942
• ISBN10: 0198296940
• Format: Hardcover
• Copyright: 2002-02-28
• Publisher: Oxford University Press

Summary

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 thatinvestors 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 inisolation 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 wealthitself, 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 hadlittle 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 saferassets 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 tounderstand the portfolio choice problems of long-term investors.

Table of Contents

List of Figures	xiii
List of Tables	xiv
Introduction	1	(16)
Myopic Portfolio Choice	17	(31)
Short-Term Portfolio Choice	18	(13)
Myopic Long-Term Portfolio Choice	31	(15)
Conclusion	46	(2)
Who Should Buy Long-Term Bonds?	48	(40)
Long-Term Portfolio Choice in a Model with Constant Variances and Risk Premia	50	(12)
A Model of the Term Structure of Interest Rates	62	(24)
Conclusion: Bonds, James, Bonds	86	(2)
Is the Stock Market Safer for Long-Term Investors?	88	(32)
Long-Term Portfolio Choice in a VAR Model	90	(11)
Stock and Bond Market Risk in Historical US Data	101	(16)
Conclusion	117	(3)
Strategic Asset Allocation in Continuous Time	120	(42)
The Dynamic Programming Approach	121	(12)
The Martingale Approach	133	(10)
Recursive Utility in Continuous Time	143	(4)
Should Long-Term Investors Hedge Volatility Risk?	147	(7)
Parameter Uncertainty and Portfolio Choice	154	(6)
Conclusion	160	(2)
Human Wealth and Financial Wealth	162	(33)
Single-Period Models with Labor Income	167	(15)
Labor Income, Precautionary Savings, and Long-Horizon Portfolio Choice	182	(11)
Conclusion	193	(2)
Investing over the Life Cycle	195	(31)
What Do We Know about Household Asset Allocation?	197	(5)
A Life-Cycle Model of Portfolio Choice	202	(17)
Conclusion	219	(7)
References	226	(15)
Author Index	241	(8)
Subject Index	249