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Article
Publication date: 27 May 2021

Nuno Silva

The study aims to show that ambiguity aversion exerts a non-negligible effect on the investors' decisions, especially due to the possibility of sharp declines in stock prices.

Abstract

Purpose

The study aims to show that ambiguity aversion exerts a non-negligible effect on the investors' decisions, especially due to the possibility of sharp declines in stock prices.

Design/methodology/approach

The vast majority of previous studies on life-cycle consumption and asset allocation assume that the equity premium is constant. This study evaluates the impact of rare disasters that shift the stock market to a low return state on investors' consumption and portfolio decisions. The author assumes that investors are averse to ambiguity relative to the current state of the economy and must incur a per period cost to participate in the stock market and solve their optimal consumption and asset allocation problem using dynamic programming.

Findings

The results show that most young investors choose not to invest in stocks because they have low accumulated wealth and the potential return from their stock market investments would not cover the participation costs. Furthermore, ambiguity-averse investors hold considerably fewer stocks throughout their lifetime than ambiguity-neutral ones. The fraction of wealth invested in stocks over the typical consumer's life is hump-shaped: it is low for a young individual, peaks at his early 30s and then decreases until his retirement age.

Originality/value

To the best of the author’s knowledge, this is the first study that assesses the impact of negative stock price jumps on the optimal portfolio of an ambiguity-averse investor.

Details

Review of Behavioral Finance, vol. 14 no. 5
Type: Research Article
ISSN: 1940-5979

Keywords

Book part
Publication date: 11 August 2016

Karoll Gómez Portilla

This chapter focuses on examining how changes in the liquidity differential between nominal and TIPS yields influence optimal portfolio allocations in U.S. Treasury…

Abstract

This chapter focuses on examining how changes in the liquidity differential between nominal and TIPS yields influence optimal portfolio allocations in U.S. Treasury securities. Based on a nonparametric estimation technique and comparing the optimal allocation decisions of mean-variance and CRRA investor, when investment opportunities are time varying, I present evidence that liquidity risk premium is a significant risk-factor in a portfolio allocation context. In fact, I find that a conditional allocation strategy translates into improved in-sample and out-of-sample asset allocation and performance. The analysis of the portfolio allocation to U.S. government bonds is particularly important for central banks, specially in developing countries, given the fact that, collectively they have accumulate a large holdings of U.S. securities over the last 15 years.

Details

The Spread of Financial Sophistication through Emerging Markets Worldwide
Type: Book
ISBN: 978-1-78635-155-5

Keywords

Article
Publication date: 15 August 2016

Axel Buchner

This paper aims to explore the effects of illiquidity on portfolio weight and return dynamics.

Abstract

Purpose

This paper aims to explore the effects of illiquidity on portfolio weight and return dynamics.

Design/methodology/approach

Using a novel continuous-time framework, the paper makes two key contributions to the literature on asset pricing and illiquidity. The first is to study the effects of illiquidity on portfolio weight dynamics. The second contribution is to analyze how illiquidity affects the risk/return dynamics of a portfolio.

Findings

The numerical results highlight that investors should be prepared for potentially large and skewed variations in portfolio weights and can be away from optimal diversification for a long time when adding illiquid assets to a portfolio. Additionally, the paper shows that illiquidity increases portfolio risk. Interestingly, this effect gets more pronounced when the return correlation between the illiquid and liquid asset is low. Thus, there is a correlation effect in the sense that illiquidity costs, as measured by the increase in overall portfolio risk, are inversely related to the return correlation of the assets.

Originality/value

This is the first paper that highlights that the increase in portfolio risk caused by illiquidity is inversely related to the return correlation between the liquid and illiquid assets. This important economic result contrasts with the widely used argument that the benefit of adding illiquid (alternative) assets to a portfolio is their low correlation with (traditional) traded assets. The results imply that the benefits of adding illiquid assets to a portfolio can be much lower than typically perceived.

Details

The Journal of Risk Finance, vol. 17 no. 4
Type: Research Article
ISSN: 1526-5943

Keywords

Book part
Publication date: 30 November 2011

Massimo Guidolin

I survey applications of Markov switching models to the asset pricing and portfolio choice literatures. In particular, I discuss the potential that Markov switching models…

Abstract

I survey applications of Markov switching models to the asset pricing and portfolio choice literatures. In particular, I discuss the potential that Markov switching models have to fit financial time series and at the same time provide powerful tools to test hypotheses formulated in the light of financial theories, and to generate positive economic value, as measured by risk-adjusted performances, in dynamic asset allocation applications. The chapter also reviews the role of Markov switching dynamics in modern asset pricing models in which the no-arbitrage principle is used to characterize the properties of the fundamental pricing measure in the presence of regimes.

Details

Missing Data Methods: Time-Series Methods and Applications
Type: Book
ISBN: 978-1-78052-526-6

Keywords

Article
Publication date: 21 September 2010

Ping He and Xiaoqing Hu

Individuals tend to simplify a complex portfolio decision problem into several manageable dimensions, each of which can frame their perception of risk.We check this view…

Abstract

Individuals tend to simplify a complex portfolio decision problem into several manageable dimensions, each of which can frame their perception of risk.We check this view by studying the effect of investment horizons on households’ portfolio decisions. Using the Survey of Consumer Finances (SCF) data, we find that households allocate more of their wealth in stocks if they report longer planning horizons. The existence of foreseeable expenditure significantly changes the dependence of risky stock investment on the planning horizon.We decompose the reported planning horizon into an objective part and a subjective mental accounting part, and find that the mental accounting part has a greater effect on household portfolio choice. This is consistent with the argument that individuals make investment decisions based on the horizon at which the risk is perceived rather than the horizon at which the investment reward or cash is needed.

Details

Review of Behavioural Finance, vol. 2 no. 2
Type: Research Article
ISSN: 1940-5979

Keywords

Article
Publication date: 19 June 2020

Jing Jian Xiao and Chunsheng Tao

The purpose of this literature review paper is to define consumer finance, describe the scope of consumer finance and discuss its future research directions.

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Abstract

Purpose

The purpose of this literature review paper is to define consumer finance, describe the scope of consumer finance and discuss its future research directions.

Design/methodology/approach

In this paper, consumer finance is used as a synonym of household finance. Consumers refer to individuals and families. After defining the term “consumer finance,” we conducted a critical review of consumer finance as an interdisciplinary research field in terms of money managing, insuring, borrowing and saving/investing. Future research directions are also discussed.

Findings

This paper discusses similarities and differences among several terms such as consumer finance, household finance, personal finance, family finance and behavioral finance. The paper also reviewed key studies on consumer financial behavior around four key financial functions, namely, money management, insurance, loan and saving/investment and several nontraditional topics such as fintech and financial capability/literacy. The paper also introduced several datasets of consumer finance commonly used in the United States and China.

Originality/value

This paper clarified several similar terms related to consumer finance and sorted out the diverse literature of consumer finance in multiple disciplines such as economics, finance and consumer science, which provide a foundation for generating more fruitful research in consumer finance in the future.

Details

China Finance Review International, vol. 11 no. 1
Type: Research Article
ISSN: 2044-1398

Keywords

Article
Publication date: 2 August 2013

Li Chen and Heping Pan

The purpose of this paper is to prove the effectiveness of minimum semi‐absolute deviations (MSAD) method in dynamic portfolio investment.

Abstract

Purpose

The purpose of this paper is to prove the effectiveness of minimum semi‐absolute deviations (MSAD) method in dynamic portfolio investment.

Design/methodology/approach

In financial investment, the classical static portfolio theory of Markowitz type lacks the dynamic adaptability to the changing market situations. This paper proposes a dynamic portfolio theory which uses MSAD criterion on a moving window to replace the Markowitz mean‐variance analysis.

Findings

Two specific models are developed to test the validity of the MSAD method: the first model constructs a portfolio consisting of Shanghai‐Shenzhen 300 Index and a national debt as two contrarian assets; the second model constructs a portfolio consisting of a complete set of 18 Chinese stock sector indices and a national debt. The empirical results of the test using six‐year monthly data (2005 to 2010) provide significant evidence that the MSAD method is valid, producing superior returns of investment over the stock index during the test period.

Research limitations/implications

The findings in this study clearly highlight the validity of the MSAD method in determining the weights of assets in Chinese stock markets.

Practical implications

In order to resolve the problem of portfolio investment in Chinese stock markets, the MSAD method with stop loss control strategy can be used for investors to obtain the weights of assets and control the risk.

Originality/value

This study analyzes and verifies the effectiveness of the MSAD method in dynamic portfolio investment. The stop loss control strategy designed and used in the MSAD method is a pioneering and exploratory experiment.

Article
Publication date: 1 January 1999

NICHOLAS G. POLSON and JEFFREY YASUMOTO

Standard financial models predict that investors who are willing to hold an investment in the short‐run will hold the same investment for the long‐run. It is well known…

Abstract

Standard financial models predict that investors who are willing to hold an investment in the short‐run will hold the same investment for the long‐run. It is well known that a leveraged investment's expected excess return is equal to the unlevered excess return scaled by the leverage factor. Volatility is likewise scaled‐up by the leverage factor. It is not so well known, however, that the realized terminal wealth generated by the leveraged investment is very likely to be significantly lower than its expected value. This is true because leverage induces positive skewness into the distribution of long‐run wealth. The skewness and hence the probability of achieving a lower‐than‐expected terminal wealth increases with the length of time that a leveraged investment is held. Even for moderate leverage factors, this effect can be so dramatic that the leveraged investor will lag behind the unleveraged investor.

Details

The Journal of Risk Finance, vol. 1 no. 1
Type: Research Article
ISSN: 1526-5943

Article
Publication date: 1 March 2000

WILLIAM ECKHARDT and NICHOLAS G. POLSON

An optimal investment strategy is “memoryless,” because it depends on present and expected future conditions, but not on the past. This article discusses the conditions…

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Abstract

An optimal investment strategy is “memoryless,” because it depends on present and expected future conditions, but not on the past. This article discusses the conditions required for a single, optimal investment strategy which the authors refer to as the memoryless trading rule. As a normative theory for investment decisions, memoryless trading requires an investment strategy or future course of action to describe what the trader will do when the markets achieve a given state. Memoryless trading also implies that when traders share a common utility function (which incorporates their risk preferences), wealth level, and trading orientation, there is a single, optimal investment strategy based upon market conditions. The authors show how some standard financial tools for comparing traders and measuring risk‐adjusted portfolio performance, e.g., the Sharpe ratio, violate the memoryless trading rule. They also discuss the relationship between memoryless trading and traditional equilibrium models of asset pricing.

Details

The Journal of Risk Finance, vol. 1 no. 4
Type: Research Article
ISSN: 1526-5943

Article
Publication date: 17 December 2020

Ly Dai Hung

The author studies the role of safe assets accumulation in shaping the pattern of international capital flows.

Abstract

Purpose

The author studies the role of safe assets accumulation in shaping the pattern of international capital flows.

Design/methodology/approach

The author combines a theoretical model and the empirical analysis. The model is a two-country open economy, while the evidence is based on a fixed-effect regression on a panel of 19 countries of the eurozone.

Findings

In an open two-country economy, a positive productivity shock raises both mean and variance of wealth accumulation rate, then, leading to a greater holding of safe assets for risk-sharing motivation. Upon financial integration, the shock can induce the outflows of net total capital. The evidence of 19 eurozone countries confirms the theory and also uncovers that the safe assets (bonds) are the dominant driver of cross-border capital flows within the eurozone.

Research limitations/implications

The model can be extended to account for the impact of safe assets on the economic growth, then, analyzes the role of safe assets within financial globalization. Taking into account the impact of safe assets on the open-economy economic growth can be the next step to approach the issue.

Practical implications

The paper also provides important policy implication. Since a higher productivity level can raise the outflows of net total capital through the accumulation of foreign safe assets, an economy needs to increase its supply of safe asset along with upgrading its domestic productivity level. This combination is important for the long-run capital accumulation and economic growth of an economy with an increasing path of the productivity level.

Originality/value

The paper seeks a balance between theory and evidence on international capital flows. Moreover, the paper bridges the gap between the literature on international capital flows and the literature on safe assets. And the paper also focuses on the economies of the eurozone.

Details

Journal of Economic Studies, vol. 49 no. 1
Type: Research Article
ISSN: 0144-3585

Keywords

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