Macroeconomic environment, money demand and portfolio choice

We solve the portfolio choice problem of a long-term investor holding real balances, a stock index, multiple bonds and a remunerated money market account. We relate the factors driving the term structure and the equity premium to macroeconomic variables. When expected inflation decreases, the investor allocates more to the stock market, long-term bonds and unrewarded real balances, reducing short-maturity deposits. The optimal money demand: i) entails time variations in risk aversion; ii) reduces bond market positions when the importance of money in preferences increases, with little impact on the stock market participation; and iii) has quantitative implications in terms of horizon effects.

[1]  Glenn D. Rudebusch,et al.  Resolving the Spanning Puzzle in Macro-Finance Term Structure Models , 2015, SSRN Electronic Journal.

[2]  Carl E. Walsh,et al.  Monetary Theory and Policy , 1998 .

[3]  S. Shreve,et al.  Martingale and duality methods for utility maximization in a incomplete market , 1991 .

[4]  K. Singleton,et al.  Specification Analysis of Affine Term Structure Models , 1997 .

[5]  Dennis L. Hoffman,et al.  Intertemporal asset-pricing relationships in barter and monetary economies An empirical analysis , 1990 .

[6]  G. Duffee.  Bond pricing and the macroeconomy , 2013 .

[7]  Kosuke Aoki,et al.  Household Portfolios in a Secular Stagnation World: Evidence from Japan , 2016 .

[8]  Neil D. Pearson,et al.  Consumption and portfolio policies with incomplete markets and short-sale constraints: The infinite dimensional case , 1991 .

[9]  Jean-Paul Renne,et al.  A tractable interest rate model with explicit monetary policy rates , 2016, Eur. J. Oper. Res..

[10]  L. Gu,et al.  CONSUMPTION, MONEY, INTRATEMPORAL SUBSTITUTION, AND CROSS‐SECTIONAL ASSET RETURNS , 2013 .

[11]  Andrew Ang,et al.  A no-arbitrage vector autoregression of term structure dynamics with macroeconomic and latent variables , 2003 .

[12]  Luis M. Viceira,et al.  Appendix: Monetary Policy Drivers of Bond and Equity Risks , 2020 .

[13]  M. Hashem Pesaran,et al.  Impulse response analysis in nonlinear multivariate models , 1996 .

[14]  S. V. D. Heuvel,et al.  The Welfare Cost of Bank Capital Requirements , 2008 .

[15]  Fernando Zapatero,et al.  Monte Carlo computation of optimal portfolios in complete markets , 2003 .

[16]  Malcolm P. Baker,et al.  Comovement and Predictability Relationships between Bonds and Thecross-Section of Stocks , 2010 .

[17]  X. Sala-i-Martin,et al.  A Growth Model of Inflation, Tax Evasion, and Financial Repression , 1992 .

[18]  H. Uhlig,et al.  Is Quantity Theory Still Alive? , 2010, SSRN Electronic Journal.

[19]  Ushio Sumita,et al.  Credit risk model with contagious default dependencies affected by macro-economic condition , 2011, Eur. J. Oper. Res..

[20]  Jérôme Detemple,et al.  Dynamic Asset Allocation: Portfolio Decomposition Formula and Applications , 2010 .

[21]  Andrew Ang,et al.  Stock Return Predictability: Is it There? , 2001 .

[22]  Jessica A. Wachter.  Portfolio and Consumption Decisions under Mean-Reverting Returns: An Exact Solution for Complete Markets , 2001, Journal of Financial and Quantitative Analysis.

[23]  John B. Taylor.  Discretion versus policy rules in practice , 1993 .

[24]  X. Ragot.  The Case for a Financial Approach to Money Demand , 2010 .

[25]  Andrew Ang,et al.  No-Arbitrage Taylor Rules , 2004 .

[26]  Kim P. Huynh,et al.  Consumer Cash Usage: A Cross-Country Comparison with Payment Diary Survey Data , 2014, SSRN Electronic Journal.

[27]  Andrew Ang,et al.  Monetary Policy Shifts and the Term Structure , 2009 .

[28]  Risk, Uncertainty and Monetary Policy , 2013 .

[29]  Luis M. Viceira,et al.  Spreading the Wealth Around: Reflections Inspired by Joe the Plumber , 1998 .

[30]  K. Singleton,et al.  Risk Premiums in Dynamic Term Structure Models with Unspanned Macro Risks , 2013 .

[31]  Biresh K. Sahoo,et al.  An alternative approach to monetary aggregation in DEA , 2010, Eur. J. Oper. Res..

[32]  Why Gaussian macro-finance term structure models are (nearly) unconstrained factor-VARs , 2013 .

[33]  K. Singleton,et al.  Expectation puzzles, time-varying risk premia, and affine models of the term structure , 2002 .

[34]  Volker Wieland,et al.  Interest-Rate Smoothing and Optimal Monetary Policy: A Review of Recent Empirical Evidence , 1999 .

[35]  Robert C. Feenstra,et al.  Functional equivalence between liquidity costs and the utility of money , 1986 .

[36]  P. Ireland.  Monetary Policy, Bond Risk Premia, and the Economy , 2015 .

[37]  Paresh Date,et al.  Linear Gaussian affine term structure models with unobservable factors: Calibration and yield forecasting , 2009, Eur. J. Oper. Res..

[38]  J. Cox,et al.  Optimal consumption and portfolio policies when asset prices follow a diffusion process , 1989 .

[39]  Abraham Lioui,et al.  On optimal portfolio choice under stochastic interest rates , 2001 .

[40]  Michael T. Belongia,et al.  Interest Rates and Money in the Measurement of Monetary Policy , 2012 .

[41]  K. Singleton,et al.  A New Perspective on Gaussian DTSMs , 2010 .

[42]  D. Duffie,et al.  A YIELD-FACTOR MODEL OF INTEREST RATES , 1996 .

[43]  Y. Shin,et al.  Generalized Impulse Response Analysis in Linear Multivariate Models , 1998 .

[44]  J. Detemple,et al.  A Monte Carlo Method for Optimal Portfolios , 2000 .

[45]  Abraham Lioui.  The asset allocation puzzle is still a puzzle , 2007 .

[46]  Jonathan H. Wright,et al.  The U.S. Treasury Yield Curve: 1961 to the Present , 2006 .

[47]  Maria Cristina Recchioni,et al.  From bond yield to macroeconomic instability: A parsimonious affine model , 2017, Eur. J. Oper. Res..

[48]  S. Shreve,et al.  Optimal portfolio and consumption decisions for a “small investor” on a finite horizon , 1987 .

[49]  J. Galí,et al.  Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory , 1998 .

[50]  Geert Bekaert,et al.  The Determinants of Stock and Bond Return Comovements , 2007 .

[51]  J. Galí,et al.  The Science of Monetary Policy: A New Keynesian Perspective , 1999 .

[52]  Kosuke Aoki,et al.  Inflation, Money Demand and Portfolio Choice , 2014 .

[53]  David A. Marshall.  Inflation and asset returns in a monetary economy , 1992 .

[54]  J. Galí,et al.  Monetary Policy Rules in Practice: Some International Evidence , 1997 .

[55]  Jill Ann Holman,et al.  GMM Estimation of a Money-in-the-Utility-Function Model: The Implications of Functional Forms , 1998 .

[56]  P. Collin‐Dufresne,et al.  Identification of Maximal Affine Term Structure Models , 2008 .

[57]  D. Humphrey.  Replacement of cash by cards in US consumer payments , 2004 .

[58]  K. Singleton,et al.  Term Structure Dynamics in Theory and Reality , 2002 .

[59]  Abraham Lioui,et al.  Interest Rate Risk and the Cross Section of Stock Returns , 2014, Journal of Financial and Quantitative Analysis.

[60]  R. Priestley,et al.  Time-Varying Risk Premiums and the Output Gap , 2009 .

[61]  An Asset Allocation Puzzle: Comment , 2001 .

[62]  Yihong Xia,et al.  Dynamic Asset Allocation Under Inflation , 2000 .

[63]  G. Duffee.  Term premia and interest rate forecasts in affine models , 2000 .

[64]  Bas J. M. Werker,et al.  When Can Life Cycle Investors Benefit from Time-Varying Bond Risk Premia? , 2010 .

[65]  John C. Cox,et al.  A variational problem arising in financial economics , 1991 .

[66]  Martin Eichenbaum,et al.  Some Empirical Evidence on the Effects of Shocks to Monetary Policy on Exchange Rates , 1995 .

[67]  Stijn Van Nieuwerburgh,et al.  Reconciling the Return Predictability Evidence , 2006 .

[68]  Marco Del Negro,et al.  Credit Spreads and Monetary Policy , 2009 .

[69]  Ruslan Bikbov,et al.  No-Arbitrage Macroeconomic Determinants of the Yield Curve , 2006 .

[70]  R. Lucas,et al.  On the stability of money demand , 2015 .

[71]  Francesco Lippi,et al.  Financial Innovation and the Transactions Demand for Cash , 2007 .

[72]  Gurdip Bakshi,et al.  Inflation, Asset Prices, and the Term Structure of Interest Rates in Monetary Economies , 1996 .