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Momentum and Mean Reversion in Strategic Asset Allocation

Ralph Koijen, Juan Carlos Rodríguez () and Alessandro Sbuelz ()
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Juan Carlos Rodríguez: Department of Finance, CentER, Tilburg University, 5000 LE, Tilburg, The Netherlands
Alessandro Sbuelz: Department of Mathematics, Quantitative Finance, and Econometrics, Catholic University of Milan, 20123 Milan, Italy

Management Science, 2009, vol. 55, issue 7, 1199-1213

Abstract: We study a dynamic asset allocation problem in which stock returns exhibit short-run momentum and long-run mean reversion. We develop a tractable continuous-time model that captures these two predictability features and derive the optimal investment strategy in closed form. The model predicts negative hedging demands for medium-term investors, and an allocation to stocks that is nonmonotonic in the investor's horizon. Momentum substantially increases the economic value of hedging time variation in investment opportunities. These utility gains are preserved when we impose realistic borrowing and short-sales constraints and allow the investor to trade on a monthly frequency.

Keywords: portfolio choice; investment criteria; financial institutions; investment (search for similar items in EconPapers)
Date: 2009
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Handle: RePEc:inm:ormnsc:v:55:y:2009:i:7:p:1199-1213