*Jerome L. Stein*

- Published in print:
- 2006
- Published Online:
- May 2006
- ISBN:
- 9780199280575
- eISBN:
- 9780191603501
- Item type:
- chapter

- Publisher:
- Oxford University Press
- DOI:
- 10.1093/0199280576.003.0003
- Subject:
- Economics and Finance, Financial Economics

This chapter answers the following technical questions: In a stochastic environment, where the return on capital and the interest rate are stochastic, what is an optimal (1) long-term debt, (2) ...
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This chapter answers the following technical questions: In a stochastic environment, where the return on capital and the interest rate are stochastic, what is an optimal (1) long-term debt, (2) expected current account, (3) consumption, and (4) expected growth rate. The mathematical techniques necessary to answer these questions, concerning intertemporal optimization in continuous time over an infinite horizon, involve dynamic programming. A mean-variance interpretation is given for the dynamic programming solution.Less

This chapter answers the following technical questions: In a stochastic environment, where the return on capital and the interest rate are stochastic, what is an optimal (1) long-term debt, (2) expected current account, (3) consumption, and (4) expected growth rate. The mathematical techniques necessary to answer these questions, concerning intertemporal optimization in continuous time over an infinite horizon, involve dynamic programming. A mean-variance interpretation is given for the dynamic programming solution.

*John Y. Campbell and Luis M. Viceira*

- Published in print:
- 2002
- Published Online:
- November 2003
- ISBN:
- 9780198296942
- eISBN:
- 9780191596049
- Item type:
- chapter

- Publisher:
- Oxford University Press
- DOI:
- 10.1093/0198296940.003.0001
- Subject:
- Economics and Finance, Financial Economics

The mean‐variance paradigm has the strong implication that all investors should hold risky assets in the same proportion. Financial planners typically advise conservative investors to tilt their ...
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The mean‐variance paradigm has the strong implication that all investors should hold risky assets in the same proportion. Financial planners typically advise conservative investors to tilt their risky portfolios towards bonds and away from stocks; this has been called the “asset allocation puzzle” since it contradicts standard mean‐variance analysis. Financial planners also argue that long‐term investors can afford greater exposure to stock market risk. This book will show how financial planners’ advice can be justified by an inter‐temporal model of a rational investor. The model ignores some important real‐world issues, including diversification of individual stocks, transactions costs, taxation, and the biases identified by research in behavioural finance.Less

The mean‐variance paradigm has the strong implication that all investors should hold risky assets in the same proportion. Financial planners typically advise conservative investors to tilt their risky portfolios towards bonds and away from stocks; this has been called the “asset allocation puzzle” since it contradicts standard mean‐variance analysis. Financial planners also argue that long‐term investors can afford greater exposure to stock market risk. This book will show how financial planners’ advice can be justified by an inter‐temporal model of a rational investor. The model ignores some important real‐world issues, including diversification of individual stocks, transactions costs, taxation, and the biases identified by research in behavioural finance.

*John Y. Campbell and Luis M. Viceira*

- Published in print:
- 2002
- Published Online:
- November 2003
- ISBN:
- 9780198296942
- eISBN:
- 9780191596049
- Item type:
- chapter

- Publisher:
- Oxford University Press
- DOI:
- 10.1093/0198296940.003.0002
- Subject:
- Economics and Finance, Financial Economics

Reviews the theory of portfolio choice for short‐term investors, and explains the special cases in which long‐term investors should make the same choices as short‐term investors. When investors’ ...
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Reviews the theory of portfolio choice for short‐term investors, and explains the special cases in which long‐term investors should make the same choices as short‐term investors. When investors’ relative risk aversion does not depend on their wealth, investment horizon is irrelevant for investors who have only financial wealth and who face constant investment opportunities. Even if investment opportunities are time‐varying, the investment horizon is still irrelevant for investors whose relative risk aversion equals one. However, there is strong empirical evidence that these conditions fail in various ways, thus allowing for legitimate arguments for horizon effects on portfolio choice.Less

Reviews the theory of portfolio choice for short‐term investors, and explains the special cases in which long‐term investors should make the same choices as short‐term investors. When investors’ relative risk aversion does not depend on their wealth, investment horizon is irrelevant for investors who have only financial wealth and who face constant investment opportunities. Even if investment opportunities are time‐varying, the investment horizon is still irrelevant for investors whose relative risk aversion equals one. However, there is strong empirical evidence that these conditions fail in various ways, thus allowing for legitimate arguments for horizon effects on portfolio choice.

*John Y. Campbell and Luis M. Viceira*

- Published in print:
- 2002
- Published Online:
- November 2003
- ISBN:
- 9780198296942
- eISBN:
- 9780191596049
- Item type:
- book

- Publisher:
- Oxford University Press
- DOI:
- 10.1093/0198296940.001.0001
- Subject:
- Economics and Finance, Financial Economics

One of the most important decisions many people face is the choice of a portfolio of assets for retirement savings. The leading academic paradigm of portfolio choice, the mean‐variance analysis of ...
More

One of the most important decisions many people face is the choice of a portfolio of assets for retirement savings. The leading academic paradigm of portfolio choice, the mean‐variance analysis of Markowitz, does not give adequate guidance for this long‐term investment problem because it assumes that investors care only about the mean and variance of return over a single short period. The book develops an alternative paradigm, the inter‐temporal model of Merton, into an empirically usable framework with the following implications. The safe asset for a long‐term investor is not a Treasury bill, but a long‐term inflation‐indexed bond that provides a stable stream of real income. A nominal bond is a good substitute for an inflation‐indexed bond only if inflation risk is low. There is evidence that stock returns are mean‐reverting, with bull markets tending to follow bear markets and vice versa; this suggests that long‐term investors should increase their average stockholdings but should also vary their stockholdings with the overall level of the stock market. Investors with a stable stream of labour income can afford a greater exposure to stock market risk.Less

One of the most important decisions many people face is the choice of a portfolio of assets for retirement savings. The leading academic paradigm of portfolio choice, the mean‐variance analysis of Markowitz, does not give adequate guidance for this long‐term investment problem because it assumes that investors care only about the mean and variance of return over a single short period. The book develops an alternative paradigm, the inter‐temporal model of Merton, into an empirically usable framework with the following implications. The safe asset for a long‐term investor is not a Treasury bill, but a long‐term inflation‐indexed bond that provides a stable stream of real income. A nominal bond is a good substitute for an inflation‐indexed bond only if inflation risk is low. There is evidence that stock returns are mean‐reverting, with bull markets tending to follow bear markets and vice versa; this suggests that long‐term investors should increase their average stockholdings but should also vary their stockholdings with the overall level of the stock market. Investors with a stable stream of labour income can afford a greater exposure to stock market risk.