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Portfolio Choice with Stochastic Interest Rates and Learning About Stock Return Predictability

2014
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Release : 2014
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Book Synopsis Portfolio Choice with Stochastic Interest Rates and Learning About Stock Return Predictability by : Marcos Escobar

Download or read book Portfolio Choice with Stochastic Interest Rates and Learning About Stock Return Predictability written by Marcos Escobar. This book was released on 2014. Available in PDF, EPUB and Kindle. Book excerpt: The problem of optimal wealth allocation is solved under the assumptions that interest rates are stochastic and stock returns are predictable with observed and unobserved factors. The stock risk premium is taken to be an affine function of the predictive variables and the stock return volatility is assumed to depend on the observed factor. The latent factor is estimated based on the observations. It is shown that the stock return predictability can significantly impact the optimal bond portfolio. The welfare loss from ignoring learning can be considerable.

On Optimal Portfolio Choice Under Stochastic Interest Rates

2010
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Release : 2010
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Book Synopsis On Optimal Portfolio Choice Under Stochastic Interest Rates by : Abraham Lioui

Download or read book On Optimal Portfolio Choice Under Stochastic Interest Rates written by Abraham Lioui. This book was released on 2010. Available in PDF, EPUB and Kindle. Book excerpt: In an economy where interest rates and stock price changes follow fairly general stochastic processes, we analyse the portfolio problem of an expected utility investor. When the investment opportunity set is driven by an arbitrary number of state variables, the optimal portfolio strategy is known to contain a speculative element and Merton-Breeden hedging terms against the fluctuations of each and every state variable. While the first component is well identified and easy to work out, the implementation of the last ones is problematic as the investor must identify all the relevant state variables and estimate their distribution characteristics. Using a new decomposition of the optimal wealth, we show that the optimal strategy can be simplified to include, in addition to the speculative component, only two Merton-Breeden type hedging elements, however large is the number of state variables. The first one is associated with interest rate risk and the second one with the risk brought about by the co-movements of the spot interest rate and the market prices of risk. The implementation of the optimal strategy is thus much easier, as it involves estimating the characteristics of the yield curve and the market prices of risk only rather than those of numerous (a priori unknown) state variables. Moreover, the investor's horizon is shown explicitly to play a crucial role in the optimal strategy design, in sharp contrast with the traditional decomposition.

Essays on Stock Return Predictability and Portfolio Allocation

2004 Asset allocation
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Release : 2004
Genre : Asset allocation
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Book Synopsis Essays on Stock Return Predictability and Portfolio Allocation by : Bradley Steele Paye

Download or read book Essays on Stock Return Predictability and Portfolio Allocation written by Bradley Steele Paye. This book was released on 2004. Available in PDF, EPUB and Kindle. Book excerpt:

Portfolio and Consumption Choice with Stochastic Investment Opportunities and Habit Formation in Preferences

2002
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Release : 2002
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Book Synopsis Portfolio and Consumption Choice with Stochastic Investment Opportunities and Habit Formation in Preferences by : Claus Munk

Download or read book Portfolio and Consumption Choice with Stochastic Investment Opportunities and Habit Formation in Preferences written by Claus Munk. This book was released on 2002. Available in PDF, EPUB and Kindle. Book excerpt: We study the dynamic consumption and portfolio choice of an investor who has habit formation in preferences and access to a complete financial market. For general, possibly non-Markov, dynamics of market prices, we provide an exact characterization of the optimal behavior in terms of two relatively simple and intuitively interpretable stochastic processes. We study in more detail the optimal strategies in two concrete examples of time-varying investment opportunities. Firstly, we derive a closed-form solution of the optimal consumption and portfolio choice with mean-reverting stock returns. Secondly, with Cox-Ingersoll-Ross interest rate dynamics we can express the optimal strategies in terms of the solution to a partial differential equation, which has an explicit solution for time-additive preferences, but not with habit formation. Our numerical examples show that, while hedging demands for various assets are affected differently by habit persistence, the main effect on relative asset allocations stems from the fact that some assets (bonds and cash) are better investment objects than others (stocks) when it comes to ensuring that future consumption will not fall below the habit level. The implications of habit persistence in models with labor income are also addressed.

Multiscale Stochastic Volatility for Equity, Interest Rate, and Credit Derivatives

2011-09-29 Mathematics
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Release : 2011-09-29
Genre : Mathematics
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Book Rating : 45X/5 ( reviews)

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Book Synopsis Multiscale Stochastic Volatility for Equity, Interest Rate, and Credit Derivatives by : Jean-Pierre Fouque

Download or read book Multiscale Stochastic Volatility for Equity, Interest Rate, and Credit Derivatives written by Jean-Pierre Fouque. This book was released on 2011-09-29. Available in PDF, EPUB and Kindle. Book excerpt: Building upon the ideas introduced in their previous book, Derivatives in Financial Markets with Stochastic Volatility, the authors study the pricing and hedging of financial derivatives under stochastic volatility in equity, interest-rate, and credit markets. They present and analyze multiscale stochastic volatility models and asymptotic approximations. These can be used in equity markets, for instance, to link the prices of path-dependent exotic instruments to market implied volatilities. The methods are also used for interest rate and credit derivatives. Other applications considered include variance-reduction techniques, portfolio optimization, forward-looking estimation of CAPM 'beta', and the Heston model and generalizations of it. 'Off-the-shelf' formulas and calibration tools are provided to ease the transition for practitioners who adopt this new method. The attention to detail and explicit presentation make this also an excellent text for a graduate course in financial and applied mathematics.

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