Dynamic Asset Allocation and Fixed Income Management

This paper provides the solution to an intertemporal investment problem. The investor has power utility and can invest in stocks and bonds in a complete market setting where the Vasicek term structure model applies. The paper demonstrates that the zero-coupon bond with maturity at the investment horizon is the appropriate instrument for hedging changes in the opportunity set. Implementation issues are discussed and it is shown how the intertemporal investment problem can be recast as a series of mean-variance problems in terms of drift and volatility of the wealth forward price. An application based on a quasi-dynamic programming approach is considered.

[1]  Peter Ove Christensen,et al.  Duration, Convexity, and Time Value , 1994 .

[2]  Oldrich A. Vasicek.  An equilibrium characterization of the term structure , 1977 .

[3]  Eduardo S. Schwartz,et al.  The Role of Learning in Dynamic Portfolio Decisions ? , 1998 .

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

[5]  F. R. Macaulay,et al.  The Movements of Interest Rates, Bond Yields and Stock Prices in the United States since 1856. , 1939 .

[6]  Eduardo S. Schwartz,et al.  Strategic asset allocation , 1997 .

[7]  R. C. Merton,et al.  Continuous-Time Finance , 1990 .

[8]  Ts Kim,et al.  Dynamic Nonmyopic Portfolio Behavior , 1994 .

[9]  Ren-Raw Chen,et al.  Maximum Likelihood Estimation for a Multifactor Equilibrium Model of the Term Structure of Interest Rates , 1993 .

[10]  Andrea Beltratti,et al.  Stock Prices and Bond Yields: Can Their Comovements Be Explained in Terms of Present Value Models? , 1992 .

[11]  R. C. Merton,et al.  Optimum consumption and portfolio rules in a continuous - time model Journal of Economic Theory 3 , 1971 .

[12]  A. Siegel,et al.  Parsimonious modeling of yield curves , 1987 .

[13]  R. C. Merton,et al.  AN INTERTEMPORAL CAPITAL ASSET PRICING MODEL , 1973 .

[14]  J. Campbell.  Stock Returns and the Term Structure , 1985 .

[15]  E. Fama,et al.  BUSINESS CONDITIONS AND EXPECTED RETURNS ON STOCKS AND BONDS , 1989 .

[16]  J. Ingersoll.  Theory of Financial Decision Making , 1987 .

[17]  G. Kaufman,et al.  Duration models , 1988 .

[18]  D. Duffie.  Dynamic Asset Pricing Theory , 1992 .

[19]  Stephen A. Ross,et al.  Duration and the Measurement of Basis Risk , 1979 .

[20]  Campbell R. Harvey,et al.  An Empirical Comparison of Alternative Models of the Short-Term Interest Rate , 1992 .

[21]  Roman L. Weil,et al.  Duration Forty Years Later , 1978 .

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

[23]  S. Ross,et al.  A theory of the term structure of interest rates'', Econometrica 53, 385-407 , 1985 .

[24]  Darrell Duffie,et al.  Implementing Arrow-Debreu equilbria by continuous trading of a few long-lived securities , 1985 .