Optimal Dynamic Portfolio Risk with First-Order and Second-Order Predictability

Christian Gollier ()

The B.E. Journal of Theoretical Economics, 2004, vol. 4, issue 1, 35

Abstract: We consider a two-period portfolio problem with predictable assets returns. First-order (second-order) predictability means that an increase in the first period returns yields a first-order (second-order) stochastically dominated shift in the distribution of the second period state prices. Mean reversion in stock returns, Bayesian learning, stochastic volatility and stochastic interest rates (bond portfolios) belong to one of these two types of predictability. We first show that a first-order stochastically dominated shift in the state price density reduces the marginal value of wealth if and only if relative risk aversion is uniformly larger than unity. This implies that first-order predictability generates a positive hedging demand for portfolio risk if this condition is met. A similar result is obtained with second-order predictability under the condition that absolute prudence be uniformly smaller than twice the absolute risk aversion. When relative risk aversion is constant, these two conditions are equivalent. We also examine the effect of exogenous predictability, i.e., when the information about the future opportunity set is conveyed by signals not contained in past asset prices.

Keywords: portfolio choice; predictability; mean-reversion; learning; bond portfolio; stochastic volatility (search for similar items in EconPapers)
Date: 2004
References: View complete reference list from CitEc
Citations: View citations in EconPapers (9)

Downloads: (external link)
https://doi.org/10.2202/1534-5971.1070 (text/html)
For access to full text, subscription to the journal or payment for the individual article is required.

Related works:
Working Paper: Optimal Dynamic Portfolio Risk with First-Order and Second-Order Predictability (2003)
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:bpj:bejtec:v:contributions.4:y:2004:i:1:n:4

Ordering information: This journal article can be ordered from
https://www.degruyter.com/journal/key/bejte/html

DOI: 10.2202/1534-5971.1070

Access Statistics for this article

The B.E. Journal of Theoretical Economics is currently edited by Burkhard C. Schipper

More articles in The B.E. Journal of Theoretical Economics from De Gruyter
Bibliographic data for series maintained by Peter Golla ().