Hedging demand in long-term asset allocation with an application to carry trade strategies
Hedging demand in long-term asset allocation with an application to carry trade strategies
We derive a closed-form expression for the mean and marginal hedging demand on risky assets in long-term asset allocation problems for individuals with CRRA preferences. Our parametric portfolio policy rule accommodates an arbitrarily large number of state variables for predicting the state of nature, and number of assets in the portfolio. The closedform expression for the hedging demand is exact under polynomial specifications of the portfolio policy rule and a suitable approximation for unknown smooth parametric portfolio policy rules using Taylor expansions. The hedging demand on risky assets depends positively on the predictability of the risky asset and the persistence of the predictors, and negatively on the degree of investor’s relative risk aversion. We illustrate these insights empirically for a basket of currencies by showing the outperformance of rebalancing carry trade strategies over different investment horizons against a short-term (myopic) portfolio
472–504
Laborda, Ricardo
c50eae59-9323-4cb0-a418-d51dd42c9986
Olmo, Jose
706f68c8-f991-4959-8245-6657a591056e
23 October 2020
Laborda, Ricardo
c50eae59-9323-4cb0-a418-d51dd42c9986
Olmo, Jose
706f68c8-f991-4959-8245-6657a591056e
Laborda, Ricardo and Olmo, Jose
(2020)
Hedging demand in long-term asset allocation with an application to carry trade strategies.
Journal of Financial Econometrics, 20 (3), .
(doi:10.1093/jjfinec/nbaa034).
Abstract
We derive a closed-form expression for the mean and marginal hedging demand on risky assets in long-term asset allocation problems for individuals with CRRA preferences. Our parametric portfolio policy rule accommodates an arbitrarily large number of state variables for predicting the state of nature, and number of assets in the portfolio. The closedform expression for the hedging demand is exact under polynomial specifications of the portfolio policy rule and a suitable approximation for unknown smooth parametric portfolio policy rules using Taylor expansions. The hedging demand on risky assets depends positively on the predictability of the risky asset and the persistence of the predictors, and negatively on the degree of investor’s relative risk aversion. We illustrate these insights empirically for a basket of currencies by showing the outperformance of rebalancing carry trade strategies over different investment horizons against a short-term (myopic) portfolio
Text
Hedging demand Laborda Olmo final
- Accepted Manuscript
More information
Accepted/In Press date: 21 August 2020
Published date: 23 October 2020
Identifiers
Local EPrints ID: 443967
URI: http://eprints.soton.ac.uk/id/eprint/443967
ISSN: 1479-8409
PURE UUID: 8ab68d8b-2055-4842-a478-433b5384d5d6
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Date deposited: 18 Sep 2020 16:31
Last modified: 17 Mar 2024 05:54
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Author:
Ricardo Laborda
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