Extending the demand system approach to asset pricing

Thomas Gehrig, Leopold Sögner () and Arne Westerkamp ()
Additional contact information
Leopold Sögner: Institute for Advanced Studies
Arne Westerkamp: IQAM Invest GmbH

Financial Markets and Portfolio Management, 2025, vol. 39, issue 1, No 4, 133-166

Abstract: Abstract This article introduces a shrinkage procedure which allows to improve upon the parametric portfolio approach introduced in Brandt et al (Review of Financial Studies 22(9): 3411–3477, 2009) and more general factor conditional frameworks. We analyze optimal investment decisions for constant absolute and constant relative risk aversion. In both preference classes, especially out-of-sample performance of the optimal strategies is rather volatile. In order to reduce parameter and model uncertainty, we augment the optimal strategies by a shrinkage device that pulls the portfolio weights toward a predetermined policy portfolio. Our theoretical approach thereby extends the demand systems approach of Koijen and Yogo (Journal of Political Economy, 127(4):1475–1515, 2019) to more general classes of preferences and provides conditions for the existence of equilibrium. As a side product, we establish that the characteristics-based parametric portfolio approach of Brandt et al. (Review of Financial Studies 22(9): 3411–3477, 2009) can only be justified as optimal investments under exceedingly strong assumptions. In empirical US data, our shrinkage approach outperforms the parametric approach and the naive 1/N-strategy over quite a wide range of levels of absolute and relative risk aversion.

Keywords: Parametric portfolio policy; Expected utility; Risk aversion (search for similar items in EconPapers)
JEL-codes: C51 G11 G12 (search for similar items in EconPapers)
Date: 2025
References: Add references at CitEc
Citations:

Downloads: (external link)
http://link.springer.com/10.1007/s11408-024-00463-4 Abstract (text/html)
Access to full text is restricted to subscribers.

Related works:
Working Paper: Extending the Demand System Approach to Asset Pricing (2022)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:kap:fmktpm:v:39:y:2025:i:1:d:10.1007_s11408-024-00463-4

Ordering information: This journal article can be ordered from
http://www.springer. ... nt/journal/11408/PS2

DOI: 10.1007/s11408-024-00463-4

Access Statistics for this article

Financial Markets and Portfolio Management is currently edited by Manuel Ammann

More articles in Financial Markets and Portfolio Management from Springer, Swiss Society for Financial Market Research Contact information at EDIRC.
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().