Knowledge that Transforms

Journal Article Cover Get access The Review of Financial Studies, Volume 23, Issue 10, October 2010, Page NP, https://doi.org/10.1093/rfs/hhq097 Published: 01 October 2010

Cover Get access The Review of Financial Studies, Volume 23, Issue 12, December 2010, Page NP, https://doi.org/10.1093/rfs/hhq133 Published: 01 December 2010

Cover Get access The Review of Financial Studies, Volume 23, Issue 11, November 2010, Page NP, https://doi.org/10.1093/rfs/hhq117 Published: 01 November 2010

Journal Article Cover Get access The Review of Financial Studies, Volume 23, Issue 9, September 2010, Page NP, https://doi.org/10.1093/rfs/hhq101 Published: 01 September 2010

Toronto and University of Warwick for helpful comments. All errors are our responsibility. Dynamic Mean-Variance Asset Allocation Mean-variance criteria remain prevalent in multi-period problems, and yet not much is known about their dynamically optimal policies. We provide a fully analytical characterization of the optimal dynamic mean-variance portfolios within a general incomplete-market economy, and recover a simple structure that also inherits several conventional properties of static models. We also identify a probability measure that incorporates intertemporal hedging demands and facilitates much tractability in the explicit computation of portfolios. We solve the problem by explicitly recognizing the time-inconsistency of the mean-variance criterion and deriving a recursive representation for it, which makes dynamic programming applicable. We further show that our time-consistent solution is generically different from the pre-commitment solutions in the extant literature, which maximize the mean-variance criterion at an initial date and which the investor commits to follow despite incentives to deviate. We illustrate the usefulness of our analysis by explicitly computing dynamic mean-variance portfolios under various stochastic investment opportunities in a straightforward way, which does not involve solving a Hamilton-Jacobi-Bellman

Traditional portfolio balance theory derives a downward sloping currency demand function from limited international asset substitutability. Historically, this theory enjoyed little empirical support. We provide direct evidence by examining the exchange rate effect of a major redefinition of the MSCI Global Equity Index in 2001 and 2002. The index redefinition implied large changes in the representation of different countries in the MSCI Global Equity Index and therefore produced strong exogenous equity flows by index funds. Our event study reveals that countries with a relatively increasing equity representation experienced a relative currency appreciation upon announcement of the index change. Moreover, stock markets that are upweighted (downweighted) feature a higher (lower) permanent comovement of their currency with the basket of other MSCI currencies.

In the cross-section of U.S. households, the portfolio share in risky assets rises in wealth. The standard life-cycle model with power utility and non-tradable labor income has the counterfactual implication that the portfolio share declines in wealth. We develop a life-cycle model in which household utility depends on two types of consumption goods, basic and luxury. The model predicts that the expenditure share for basic goods declines in total consumption, and the variance of consumption growth rises in the level of consumption. When calibrated to match these two predictions in household consumption data, the model explains portfolio shares that rise in wealth.

Debt; Bank loans

We examine how long-run consumption risk arises endogenously in a standard pro-duction economy model where the representative agent has Epstein-Zin preferences. We show that even when technology growth is i.i.d., optimal consumption smoothing induces long run risk- highly persistent variation in expected consumption growth. As a consequence, the model can account for a high price of risk although both consump-tion growth volatility and the coe ¢ cient of relative risk aversion are low. The asset pricing implications of endogenous long-run risk depend crucially on the persistence of technology shocks and investorspreference for the timing of resolution of uncertainty.