Working Paper: NBER ID: w18768
Authors: John H. Cochrane
Abstract: Mean-variance portfolio theory can apply to the streams of payoffs such as dividends following an initial investment, in place of one-period returns. This description is especially useful when returns are not independent over time and investors have non-marketed income. Investors hedge their outside income streams, and then their optimal payoff is split between an indexed perpetuity - the risk-free payoff - and a long-run mean-variance efficient payoff. "Long-run" moments sum over time as well as states of nature. In equilibrium, long-run expected returns vary with long-run market betas and outside- income betas. State-variable hedges do not appear in optimal payoffs or this equilibrium.
Keywords: No keywords provided
JEL Codes: G11; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| optimal payoff stream for an investor (G11) | expected returns on the payoff streams (G19) |
| optimal payoff stream for an investor (G11) | associated risks (I12) |
| equilibrium market payoff (D53) | long-run mean-variance frontier (G11) |
| no outside income (H24) | preference for a payoff that is a linear combination of an indexed perpetuity and the market payoff (G19) |
| risk-averse investors (G11) | preference towards the perpetuity (D15) |
| long-run expected yields (G12) | long-run market betas (G12) |
| long-run market betas (G12) | covariance of asset payoffs with the market payoff over time (G19) |
| optimal risky payoff (G11) | combination of the market payoff and a hedge payoff for outside income (G19) |