Strategic Asset Allocation In A Continuous-Time VAR Model

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Overview: This article derives an approximate solution to a continuous-time intertemporal portfolio and consumption choice problem. It presents a continuous-time version of the model of optimal intertemporal portfolio choice and consumption with time-varying equity premium of Campbell and Viceira (1999). It shows that this model has an exact analytical solution when the investor has unit elasticity of intertemporal substitution in consumption and an approximate analytical solution otherwise. The problem is the continuous-time equivalent of the discrete-time problem studied by Campbell and Viceira, in which the expected excess return on a risky asset follows an AR (1) process, while the riskless interest rate is constant. It also shows how to obtain continuous-time parameters that are consistent with discrete-time econometric estimates. The continuous-time solution is numerically close to that of Campbell and Viceira and has the property that conservative long-term investors have a large positive intertemporal hedging demand for stocks. Campbell and Viceira study the impact of predictable variation in stock returns on intertemporal optimal portfolio choice and consumption. They consider an infinitely lived investor who faces a constant risk less interest rate and a time-varying equity premium.

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Format: PDF | Size: 211KB | Date: Sep 2002 | Pages: 24

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