The relative performance of several portfolio selection strategies is assessed empirically. These strategies vary in sophistication from a ‘naive’ strategy of maintaining equal dollar investments in each stock available to a strategy that periodically uses updated parameter estimates to calculate new optimal proportions of portfolio value to be invested in the stocks available. Although it is to be expected a priori that relatively sophisticated strategies will perform at least as well as the more naive strategies, implementation costs will clearly differ across strategies and across investor-specific parameters such as total portfolio value. Thus estimation of the various strategies' performance gross of these costs is a necessary consideration in rational strategy selection by any given investor.

In this paper we demonstrate how certain very ordinary economic principles lead maximizing individuals to choose consumption-production plans that display many of the characteristics commonly associated with business cycles. Our explanation is entirely consistent with (i) rational expectations, (ii) complete current information, (iii) stable preferences, (iv) no technological change, (v) no long-lived commodities, (vi) no frictions or adjustment costs, (vii) no government, (viii) no money, and (ix) no serial dependence in the stochastic elements of the environment. We also provide a completely worked out example of the type of artificial economy we have in mind. The time-series properties of the example exhibit some major features of observed business cycles. Although this type of model may not be capable of explaining all of the regularities in actual business cycles, we believe that it provides a useful, well-defined benchmark for assessing the relative importance of factors (e.g., monetary disturbances) that we have deliberately ignored.

In this paper we demonstrate how certain very ordinary economic principles lead maximizing individuals to choose consumption-production plans that display many of the characteristics commonly associated with business cycles. Our explanation is entirely consistent with (i) rational expectations, (ii) complete current information, (iii) stable preferences, (iv) no technological change, (v) no long-lived commodities, (vi) no frictions or adjustment costs, (vii) no government, (viii) no money, and (ix) no serial dependence in the stochastic elements of the environment. We also provide a completely worked out example of the type of artificial economy we have in mind. The time-series properties of the example exhibit some major features of observed business cycles. Although this type of model may not be capable of explaining all of the regularities in actual business cycles, we believe that it provides a useful, well-defined benchmark for assessing the relative importance of factors (e.g., monetary disturbances) that we have deliberately ignored.

[The dynamics of the unobservable short rate are frequently estimated directly using a proxy. We examine the biases resulting from this practice (the "proxy problem"). Analytic results show that the proxy problem is not economically significant for single-factor affine models. In the two-factor affine model of Longstaff and Schwartz (1992), the proxy problem is only economically significant for pricing discount bonds with maturities of more than five years. We also describe two different numerical procedures for assessing the magnitude of the proxy problem in a general interest rate model. When applied to a nonlinear single-factor model, they suggest that the proxy problem can be economically significant.]

The dynamics of the unobservable short rate are frequently estimated directly using a proxy. We examine the biases resulting from this practice (the “proxy problem”). Analytic results show that the proxy problem is not economically significant for single-factor affine models. In the two-factor affine model of Longstaff and Schwartz (1992), the proxy problem is only economically significant for pricing discount bonds with maturities of more than five years. We also describe two different numerical procedures for assessing the magnitude of the proxy problem in a general interest rate model. When applied to a nonlinear single-factor model, they suggest that the proxy problem can be economically significant.

John B. Long, Jr., Eduardo S. Schwartz, Financial Theory and Taxation in an Inflationary World: Some Public Policy Issues: Discussion, The Journal of Finance, Vol. 34, No. 2, Papers and Proceedings, Thirty-Seventh Annual Meeting, American Finance Association, Chicago, Illinois, August 29-31, 1978 (May, 1979), pp. 385-386