Working Paper: NBER ID: w8566
Authors: John Y. Campbell; Yeung Lewis Chan; Luis M. Viceira
Abstract: Much recent work has documented evidence for predictability of asset returns. We show how such predictability can affect the portfolio choices of long-lived investors who value wealth not for its own sake but for the consumption their wealth can support. We develop an approximate solution method for the optimal consumption and portfolio choice problem of an infinitely-lived investor with Epstein-Zin utility who faces a set of asset returns described by a vector autoregression in returns and state variables. Empirical estimates in long-run annual and postwar quarterly US data suggest that the predictability of stock returns greatly increases the optimal demand for stocks. The role of nominal bonds in long-term portfolios depends on the importance of real interest rate risk relative to other sources of risk. We extend the analysis to consider long-term inflation-indexed bonds and find that these bonds greatly increase the utility of conservative investors, who should hold large positions when they are available.
Keywords: No keywords provided
JEL Codes: G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| predictability of stock returns (G17) | optimal demand for stocks (G12) |
| relative importance of real interest rate risk (E43) | role of nominal bonds in long-term portfolios (G12) |
| availability of inflation-indexed bonds (E31) | demand from risk-averse investors (D11) |