What is the SAA?

The Stategic asset allocation determines target allocation for different asset classes. Evey Period the portfolio will be rebalnced to its original allocation

On what does the target allocation depends?

Expected Returns

Risk tolerance

time horizon

What types of possible investment classes exist?

Traditional

Bonds

Stocks

Alternative

Real Estate

Private Equity

When do we use the geometric mean and the arithmetic mean?

Buy and Hold -> Geometric Mean

Rebalancing -> Arithmetic Mean

What does a high Risk Premium implies in the CAPM or the Multifactor Model?

A high Risk Premium implies that the stock, wether in the CAPM oder multifactor models, with high betas are risky. Because if the Market (CAPM) oder the Factor (Multifactor) is facing a bad time, the single stock will have low returns.

What can we summerize, if the payoff of an asset tends to be as followed

high in bad times

low in bad times

High in bad times -> valuable asset to hold -> low expected return

Low in bad times -> risky asset to hold -> high expected return

How should we value assets during low consumptions?

If the assets payoff, thes are valuable assets -> low expected return

Why does equity peform badly in the short run, if we are in a high inflation periods.

High inflation -> low growth

Money illusion -> Investors use nominal discount rate instead of real discount rate

How does a long run investor behave?

He doesnt buy and hold, he constantly is buying and selling

Why should in the dynamic portfolio choice the periodic weights of an allocation change, during investing in the long run?

The dynamic portfolio choice states, that at every period the variables for an investors change.

Investment Opportunities

What are the solutions for the dynamic portfolio choice?

The solution is the “dynamic programming” or “control problem”.

We slice a long horizon problem into a series of one period problems and make a backward iteration.

Now we have a series of one periods, so the long run inverstors are just like short term invesotrs.

How does the “dynamic programming” or “control problem” solution work?

We will look backwards at our horizon.

What is the benefit from the “dynamic programming” or “control problem” strategy?

The dynamic strategy is completly known, even though it changes over the time.

Utilty could change

Returns could be predictiable

And the strategy will optimally response

What is the “Time diversification fallacy” by Samuelson.

How does this affect the losses?

Risk does not diversify over time, instead risk increases proportional over time.

Our potential losses increases.

What das the “Myopic” portfolio choice tells us in terms of risk and the investment horizon, iff the i.i.d. holds?

Under the i.i.d., the optimal portfolio is independent of the investment horizon.

Long Run = Short-Run

How does the Buy and Hold Strategy differes from the perspective, that long-term investors should behave like short-term investors?

The Buy and Hold investors does not rebalance his portfolio.

What is the “fallacy of large numbers”?

If we have infinite time, the shortfall risk goes to zero. But the average loss in the case of a default increases. So Risk does nit diversify with time nor splitting the money over independent investments.

We invest the same amount of money repeadetly and cumulating the risk

What happens, if returns deviate from the i.i.d. assumptions and are predictiable in terms of the mean and the variance?

High Returns today implies high returns tomorrow

High Returns today implies low returns tomorrow

The Mean and the Variance do no longer scale with the horizon. For example:

High Return today implies high return tomorrow, the variance will increase with horizon faster that the mean -> Stocks are worse for long run

High Return today implies low return tomorrow, the variance of long horizon is lower thant variance of one period times the long horizon-> Stocks are mor attractive

What happens, if return are predicitable in terms of weights?

The static portfolio weight changes every period. These Weights are called “myopic weights”

What is the optimal myopic portfolio choice?

If mean and volatility are constant:

What is the optimal weight in a opportunistic strategy?

How can we interpret the formula?

Optimal weight = Myopic weights + Hedging demand

Myopic Weight

One Period Solution (TAA)

Hedging demand weight

Takes advanteges of the long horizon for predictable returns and hedges against changes in the investment opportunities (SAA)

What is the main intuition of the Hedging demand?

Equities provide a hedge against theier own risk. If prices drop -> Expected Values are high.

How does the hedging demande behave, if the horizion increase?

It increases with the time horizon. It is like a leverage

What does Campbell and Viceira do in their study? What do they show in their study?

The Model that investors desire life consumption rather than portfolio return at a fixed terminal horizon.

The find out, that failing to time the market could lead to large costs in terms of the utility

Which Rebalance strategies exists?

Periodic Rebelancing (No matter what happens, you always rebalance)

Range Rebalancing (You only Rebalnce, if the weights reached a certain range)

Most Important thing is to rebalance

What is the Constant Mix (Rebalancing)

Investment in Stocks as a prportion of Wealth.

Sell Stocks when the arise, buy stocks when they fall

Define the “cushion” in the Constant Proportion portfolio insurance

It is the difference between Portfolio Value and NPV of the floor.

How does the constant proportion portfolio insurance work?

As long as the investor can tolerate the loss. We will adjust daily our portfolio.

Calculate NPV of Floor

Calculate the cushion

With the Cushion and our multiplier we can calculate our portfolio weight.

As long as we dont hit the NPV Floor with losses, we adjust our portfolio

How do we behave in the CPPI, if stock prices are rising or falling.

We will sell, if they fall and we will buy, if the rise. It is a Convex strategy

Define the liabilty hedging formula

Why cant everybody rebalance his portfolio?

Because the average investor holds the market portfolio

The Market Portfolio itself is Buy and Hold

What does the long-run expectation obey?

demograpphic change

porductivity

government policies

How is our risk aversion during

Low Consumption

High Consumption

During bad times, risk aversion could be very high

Equities perform bad

During good times, risk aversion is very low

Equities perform well

How the long run investor favorable against the short run investor in the dynamic programming?

Because the behave same, the longrun investors has the advatage from the time horizon.

What das Samuelson (1969) state and what are the necessary assumptions?

He states, that the Expected utilty does not increase with a higher fraction of risky assets with increasing time horizon.

Constat RRA, percentage of risky assets does not change regardless of the wealth

Returns are indipendent and random

The Dynamic Portfolio problem becomes a series of identical one-period problems

State the Formula for the Variance Ratio

How does an investor weight his portfolio, if the i.i.d assumotions dont hold.

The Investor will change his portfolio every weight.

Does Equity have premium in terms of consumption?

Yes, because equity covaries with consumption. If Consumption is low, returns of equity are low -> premium is needed to compesate the bearing risk

What is the standpoint of Mehra and Prescott in terms of the relationship of equity premium and consumption?

What are their reasons?

Eventhough there is a low conumption, with a reasonable risk aversion the risk premium should be below 1%.

The reasons are

Equity volatility is far higher thant consumption volatility

Equity returns are lowly correlated with consumption growth

What matters in habit utility?

The relative consumption and not the absolute consumption

How do we calculate the portfolio weight in a “Static portfolio choice”?

What is the “hedging demand” in the Oportunistic strategy?

A Investor take advatages from the long time horizon and use predictable returns to hedge against changes in the investment opportunity

What is the liability hedge?

The liability hedging portfolio is a portfolio with a high correlation with the liabilites. The Portfolio is there to ensures the liabilites are met. It is the true “risk free asset”.

Discuss how a higher fraction of stocks (relative to the risk-free asset) might be justified in the long run if returns are predictable

In the long run- investors are leveraged short run investors. They Hedge and the hedge demand increases with the time horizon. Equity is a hedge in itself. If equity prices drop, the excpected return increases. If the expected returns are high, long investors will buy even more equity.

Why is it importnt to understand why the equity risk premium exists?

For our understanding wether equities have high returns in the future

Recommending an optimal asset allocation

What is the correlation between excess stock returns and inflation?

They have a low correlation, sometimes even negative

How is the dynamic long problem formula stated?

X is the Asset weight

Wt+1 =

How should we rebalance our portfolio, if the stock returns are predictable?

We should even invest in more stocks than the rebalancing demand

State the practic framework Chhabra (2005)?

Personal Risk

Liability-Hedging Portfolio

Marekt Risk

Myopic Portfolio

Aspirational Risl

Long Term Hedging Portfolio

Last changed4 months ago