Investing for the long run when expected equity premium is nonnegative

Yugui Zhang, Jie Zhu and Xiaoneng Zhu

Pacific-Basin Finance Journal, 2020, vol. 63, issue C

Abstract: Barberis (2000) demonstrates that estimation risk plays an important role in long-run asset allocation. After incorporating estimation risk, he finds that predictability in returns makes investors allocate substantially more to stocks in the long run than in the short run. We show that, when the nonnegative equity premium (NEP) condition is imposed on predictive regressions, investors actually allocate roughly the same or less to stocks in the long run. The reason is that the NEP reduces mean reversion in returns by providing informative prior beliefs. A long-horizon investor who ignores reduction in mean reversion may overallocate to stocks by a sizeable amount.

Keywords: Asset allocation; Long horizon; Economic constraints; Equity premium; Estimation risk (search for similar items in EconPapers)
JEL-codes: C22 (search for similar items in EconPapers)
Date: 2020
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Persistent link: https://EconPapers.repec.org/RePEc:eee:pacfin:v:63:y:2020:i:c:s0927538x20302274

DOI: 10.1016/j.pacfin.2020.101397

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