Narrow Results

This paper presents of model of market closure in the management of international portfolios. We consider an investor holding a portfolio of domestic stocks and foreign stocks who faces market closure in the management of his portfolio. The investor's portfolio is affected by the exchange rate risk and different dynamics of the underlying assets during the period of trading and non-trading. The investor must determine the optimal proportions of his wealth to allocate to domestic stocks and foreign stocks during the market open and close periods. The paper investigates the effects of opening and closing on transactions demand of domestic and foreign stocks. The transactions demand at open and close periods in the securities markets are studied in the presence of information costs using the main concepts in Merton's (1987) model of capital market equilibrium with incomplete information. Using optimal control theory, we provide a solution in the general case and propose analytic solutions for the constant relative aversion utility functions. The model can be applied to solve several problems in financial economics in the presence of market closure.

In this paper, I study the equilibrium implications when some investors in the economy overweight a subset of stocks within their portfolio. I find that the excess returns for the overweighted stocks are lower, all else being equal. This has strong testable implications for stock returns. In the special case of logarithmic preferences, the riskfree rate increases and the market price of risk for the overweighted stock decreases, which create extra incentive for unconstrained agents to exit the stock market and hold bonds, hence clearing the market. The changes of stocks' volatilities are ambiguous. Finally, I provide an accurate quantification for agents' welfare. I also discuss the implications of my model in the context of defined contribution pension plans where workers hold large shares of their employer.

This paper examines the properties that a risk measure should satisfy in order to characterize an investor's preferences. In particular, we propose some intuitive and realistic examples that describe several desirable features of an ideal risk measure. This analysis is the first step in understanding how to classify an investor's risk. Risk is an asymmetric, relative, heteroskedastic, multidimensional concept that has to take into account asymptotic behavior of returns, inter-temporal dependence, risk-time aggregation, and the impact of several economic phenomena that could influence an investor's preferences. In order to consider the financial impact of the several aspects of risk, we propose and analyze the relationship between distributional modeling and risk measures. Similar to the notion of ideal probability metric to a given approximation problem, we are in the search for an ideal risk measure or ideal performance ratio for a portfolio selection problem. We then emphasize the parallels between risk measures and probability metrics, underlying the computational advantage and disadvantage of different approaches.

This paper studies the optimal investment problem for a behavioral investor with probability distortion functions and an S-shaped utility function whose utility on gains satisfies the Inada condition at infinity, albeit not necessarily at zero, in a complete continuous-time financial market model. In particular, a piecewise utility function with hyperbolic absolute risk aversion (HARA) is applied. The considered behavioral framework, cumulative prospect theory (CPT), was originally introduced by [A. Tversky & D. Kahneman (1992) Advances in prospect theory: Cumulative representation of uncertainty, Journal of Risk and Uncertainty5 (4), 297–323]. The utility model allows for increasing, constant or decreasing relative risk aversion. The continuous-time portfolio selection problem under the S-shaped HARA utility function in combination with probability distortion functions on gains and losses is solved theoretically for the first time, the optimal terminal wealth and its replicating wealth process and investment strategy are stated. In addition, conditions on the utility and the probability distortion functions for well-posedness and closed-form solutions are provided. A specific probability distortion function family is presented which fulfills all those requirements. This generalizes the work by [H. Jin & X. Y. Zhou (2008) Behavioral portfolio selection in continuous time, Mathematical Finance18 (3), 385–426]. Finally, a numerical case study is carried out to illustrate the impact of the utility function and the probability distortion functions.

I study the allocation problem of investors who hold their portfolio until reaching a target wealth. The strategy suppresses final wealth uncertainty but creates a time horizon risk. I begin with a classical mean variance model transposed in the duration domain, then study a dynamic portfolio choice problem with Generalized Expected Discounted Utility preferences. Using long-term US return data, I show in the mean variance model that a large amount of time horizon risk can be diversified away by investing a significant share of equities. In the dynamic model, more impatient investors are also more averse to timing risk and invest less in equities. The optimal equity share is downward trending as accumulated wealth approaches its target.

This paper studies dynamic asset allocations across stocks, Treasury bonds, and corporate bond indices. We employ a new model where liquidity plays an important role in forecasting excess returns. We document the significant utility benefits an investor gains by optimally including corporate bond indices in his portfolio. The benefits are bigger for lower-grade bonds. We also find that investment-grade indices are different from high-yield indices in that different risks are priced in these two asset classes. One important difference is that there exist positive "flight-to-liquidity" premia in investment-grade bonds, but we find no such premia in high-yield bonds. We calculate the portfolio behavior and the utility benefits for three types of investors, the "sophisticated", the "average" and the "lazy" investor. We provide practical portfolio advice on investing throughout the business cycle and we study how the total allocations and hedging demands vary with the business conditions. In addition, utilizing our model, we evaluate the significance of the liquidity variable information for the investor. We find that the liquidity information greatly enhances the investor's portfolio performance. Finally, further support in the optimality of the strategies is provided by calculating their in- and out-of-sample realized returns for the last decade.

This paper examines the impact of status-seeking considerations on investors' portfolio choices and asset prices in a general equilibrium setting. The economy studied in this paper consists of traditional ("Markowitz") investors as well as status-seekers who are concerned about relative wealth. The model highlights the strategic and interdependent nature of portfolio selection in such a setting: Low-status investors look for portfolio choices that maximize their chances of moving up the ladder while high-status investors look to maintain the status quo and hedge against these choices of the low-status investors. In equilibrium, asset returns obey a novel two-factor model in which one factor is the traditional market factor and the other is a particular "high volatility factor" that does not appear to have been identified so far in the theoretical or empirical literature. This two-factor model found significant support when tested with stock market data. Of particular interest is that the model and the empirical results attribute the low returns on idiosyncratic volatility stocks to their covariance with the portfolio of highly volatile stocks held by investors with relatively low status.

This paper shows that the stylized fact of average mutual fund underperformance documented in the literature stems from expansion periods when funds have statistically significant negative risk-adjusted performance and not recession periods when risk-adjusted fund performance is positive. These results imply that traditional unconditional performance measures understate the value added by active mutual fund managers in recessions, when investors' marginal utility of wealth is high. The risk-adjusted performance (or alpha) difference between recession and expansion periods is statistically and economically significant at 3% to 5% per year. Our findings are based on a novel multi-variate conditional regime-switching performance methodology used to carry out one of the most comprehensive examinations of the performance of US domestic equity mutual funds in recessions and expansions from 1962 to 2005. The findings are robust to the choice of the factor model (including bond and liquidity factor extensions), the use of NBER business cycle dates, fund load, turnover, expenses and percentage of equity holdings.

We compare the portfolio choices of Humans — prospect theory investors — to the portfolio choices of Econs — power utility and mean-variance (MV) investors. In a numerical example, prospect theory portfolios are decidedly unreasonable. In an in-sample asset allocation setting, the prospect theory results are consistent with myopic loss aversion. However, the portfolios are extremely unstable. The power utility and MV results are consistent with traditional finance theory, where the portfolios are stable across decision horizons. In an out-of-sample asset allocation setting, the power utility and portfolios outperform the prospect theory portfolios. Nonetheless the prospect theory portfolios with loss aversion coefficients of 2.25 and 2 perform well.

We present a simple stochastic representation for the joint distribution of sample estimates of three scalar parameters and two vectors of portfolio weights that characterize the minimum-variance frontier. This stochastic representation is useful for sampling observations efficiently, deriving moments in closed-form, and studying the distribution and performance of many portfolio strategies that are functions of these five variables. We also present the asymptotic joint distributions of these five variables for both the standard regime and the high-dimensional regime. Both asymptotic distributions are simpler than the finite-sample one, and the one for the high-dimensional regime, i.e. when the number of assets and the sample size go together to infinity at a constant rate, reveals the high-dimensional properties of the considered estimators. Our results extend upon T. Bodnar, H. Dette, N. Parolya and E. Thorstén [Sampling distributions of optimal portfolio weights and characteristics in low and large dimensions, Random Matrices: Theory Appl. 11 (2022) 2250008].

We show analytically that animal spirit excess profits for uninformed investors fall (increase) when the risk-free rate rises (falls). In the theoretical analysis, we examine the expected returns of risk-averse, short-lived investors. In addition, we find empirically that the local risk-free rates explain 14% of the changes in the animal spirit excess profits in the global stock markets for the last 29 years when the animal spirits is characterized as a product of the trend-chasing rule.

I clarify and combine the results of Ilomäki (2016a) and Ilomäki (2016b) and find several interesting conclusions. First, the effect of the animal spirits component to the expected returns of investors depends on the risk-free rate. Second, there must be an upper limit for the risk-free rate, where the component that reduces the expected returns of informed investors in Ilomäki (2016a) disappears. Third, the empirical results of Ilomäki (2016b) indicates that the break-even level is as low as 3%.

This paper examines how religion influences financial risk-taking behaviour and gambling using a survey data set from Japan, where most religious people claim they believe in Buddhism and/or Shinto. We find little association between religiousness and portfolio choice. Exceptions are that: (i) those who claimed their religion is Buddhism and the members of one Buddhist denomination are more likely to buy stock and lottery tickets than nonreligious people, and (ii) those who described themselves as devoted to religion are less likely to play pachinko.

Analyzing the correlation matrix of listed stocks, we identify “singletons” that table minimal cross-sectional correlations. Portfolios comprising 100–500 singletons all have lower betas and standard deviations and, correspondingly, higher average Sharpe and Treynor ratios than the Center for Research in Security Prices (CRSP) universe over the sample time period 1950–2017. Portfolios of singletons chosen from subsets of the CRSP universe, including small-value, low-variability, and momentum stocks, similarly realize lower portfolio standard deviations and higher risk-adjusted returns. These well-diversified portfolios suggest that the positive abnormal returns to low-beta portfolios are driven by their component stocks having low average cross-sectional correlation. One of the authors invested $20,000 of his own money in the algorithm-chosen 240 stock singleton portfolio over a 4-year period (2015–2018) and beat the market year-by-year on a risk-adjusted basis just as our results predicted.

The idea behind the optimal ESG portfolio (OESGP) is to expand the mean–variance theory by adding the portfolio ESG value (PESGV) multiplied by the ESG strength parameter γ (which is the investor’s choice) to the minimizing objective function [26,27]. PESGV is assumed to be the sum of portfolio constituents’ weighted ESG ratings that are offered by several providers. In this work, we analyzed the sensitivity of the OESGP based on the constituents of the Dow Jones Index to the ESG ratings provided by MSCI, S&P Global, and Sustainalytics. We describe discrepancies among various ESG ratings for the same securities and their effects on the OESGP performance. We found that with growing γ, the OESGP diversity and Sharpe ratio may monotonically decrease. However, the ESG-tilted Sharpe ratio has one or two maximums. The 1st maximum exists at moderate values of γ and yields a moderately diversified OESGP, which can serve as a criterion for optimal ESG portfolios. The 2nd maximum at large γ corresponds to highly concentrated OESGPs. It appears as if the portfolio has one or two securities with a lucky combination of high returns and high ESG ratings.

We develop an approximate solution method for the optimal consumption and portfolio choice problem of an infinitely long-lived investor with Epstein–Zin utility who faces a set of asset returns described by a vector autoregression in returns and state variables. Empirical estimates in long-run annual and post-war quarterly U.S. data suggest that the predictability of stock returns greatly increases the optimal demand for stocks. The role of nominal bonds in long-term portfolios depends on the importance of real interest rate risk relative to other sources of risk. Long-term inflation-indexed bonds greatly increase the utility of conservative investors.