Laborda, Ricardo and Olmo, Jose (2020) Hedging demand in long-term asset allocation with an application to carry trade strategies. Journal of Financial Econometrics. (In Press)
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
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- Faculties (pre 2018 reorg) > Faculty of Engineering and the Environment (pre 2018 reorg) > Southampton Marine & Maritime Institute (pre 2018 reorg)
- Current Faculties > Faculty of Social Sciences > School of Economic Social and Political Science > Economics
School of Economic Social and Political Science > Economics
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