Momentum and Mean-Reversion in Strategic Asset Allocation
Preprint
- 27 January 2009
- preprint
- Published by Elsevier in SSRN Electronic Journal
Abstract
We study a dynamic asset allocation problem in which stock returns exhibit short-run momentum and long-run mean reversion. We develop a tractable continuous-time model that captures these two predictability features and derive the optimal investment strategy in closed-form. The model predicts negative hedging demands for medium-term investors, and an allocation to stocks that is non-monotonic in the investor's horizon. Momentum substantially increases the economic value of hedging time-variation in investment opportunities. These utility gains are preserved when we impose realistic borrowing and short-sales constraints and allow the investor to trade on a monthly frequency.Keywords
This publication has 16 references indexed in Scilit:
- Reconciling the Return Predictability EvidencePublished by National Bureau of Economic Research ,2006
- Predicting the Equity Premium with Dividend RatiosManagement Science, 2003
- Momentum and Autocorrelation in Stock ReturnsThe Review of Financial Studies, 2002
- A Time-Series Model of Stock Returns with a Positive Short-Term Correlation and a Negative Long-Term CorrelationReview of Quantitative Finance and Accounting, 2002
- Valuing American Options by Simulation: A Simple Least-Squares ApproachThe Review of Financial Studies, 2001
- An Anatomy of Trading StrategiesThe Review of Financial Studies, 1998
- Returns to Buying Winners and Selling Losers: Implications for Stock Market EfficiencyThe Journal of Finance, 1993
- Permanent and Temporary Components of Stock PricesJournal of Political Economy, 1988
- Stock Market Prices Do Not Follow Random Walks: Evidence from a Simple Specification TestThe Review of Financial Studies, 1988
- Optimum consumption and portfolio rules in a continuous-time modelJournal of Economic Theory, 1971