Portfolio Choice under Inflation: Are Popular Recommendations Consistent with Rational Behavior?

Claus Munk, Carsten Sørensen, Tina Nygaard Vinther

Research output: Working paperResearch

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Abstract

We consider the optimal asset allocation choice of an investor who can invest in cash (a money market bank account), nominal bonds, and stocks (the stock index). The investor faces an incomplete market setting and is not able to perfectly hedge long run real interest rate risk using the available securities. The optimal investment strategy is consistent with the following features of popular investment advice which have been pointed out as puzzles: (i) a decreasing fraction of stocks in the portfolio as time passes towards the investment horizon, and (ii) a higher bond to stock ratio for more conservative (less risk tolerant) investors (Canner, Mankiw and Weil, 1997). The model for asset price dynamics is calibrated to US market data and, furthermore, risk aversion parameters and time horizons are calibrated so as to obtain a match between the optimal asset allocations and observed investment recommendations for \aggressive," \moderate," and \conservative" investor groups with different investment horizons.
Original languageEnglish
Place of PublicationFrederiksberg
PublisherInstitut for Finansiering, Copenhagen Business School
Number of pages21
Publication statusPublished - Sep 2001
SeriesWorking Papers / Department of Finance. Copenhagen Business School
Number2001-6
ISSN0903-0352

Cite this

Munk, C., Sørensen, C., & Vinther, T. N. (2001). Portfolio Choice under Inflation: Are Popular Recommendations Consistent with Rational Behavior? Frederiksberg: Institut for Finansiering, Copenhagen Business School. Working Papers / Department of Finance. Copenhagen Business School, No. 2001-6
Munk, Claus ; Sørensen, Carsten ; Vinther, Tina Nygaard. / Portfolio Choice under Inflation : Are Popular Recommendations Consistent with Rational Behavior?. Frederiksberg : Institut for Finansiering, Copenhagen Business School, 2001. (Working Papers / Department of Finance. Copenhagen Business School; No. 2001-6).
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Munk, C, Sørensen, C & Vinther, TN 2001 'Portfolio Choice under Inflation: Are Popular Recommendations Consistent with Rational Behavior?' Institut for Finansiering, Copenhagen Business School, Frederiksberg.

Portfolio Choice under Inflation : Are Popular Recommendations Consistent with Rational Behavior? / Munk, Claus; Sørensen, Carsten; Vinther, Tina Nygaard.

Frederiksberg : Institut for Finansiering, Copenhagen Business School, 2001.

Research output: Working paperResearch

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AB - We consider the optimal asset allocation choice of an investor who can invest in cash (a money market bank account), nominal bonds, and stocks (the stock index). The investor faces an incomplete market setting and is not able to perfectly hedge long run real interest rate risk using the available securities. The optimal investment strategy is consistent with the following features of popular investment advice which have been pointed out as puzzles: (i) a decreasing fraction of stocks in the portfolio as time passes towards the investment horizon, and (ii) a higher bond to stock ratio for more conservative (less risk tolerant) investors (Canner, Mankiw and Weil, 1997). The model for asset price dynamics is calibrated to US market data and, furthermore, risk aversion parameters and time horizons are calibrated so as to obtain a match between the optimal asset allocations and observed investment recommendations for \aggressive," \moderate," and \conservative" investor groups with different investment horizons.

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Munk C, Sørensen C, Vinther TN. Portfolio Choice under Inflation: Are Popular Recommendations Consistent with Rational Behavior? Frederiksberg: Institut for Finansiering, Copenhagen Business School. 2001 Sep.