PORTFOLIO ANALYSIS CONSIDERING ESTIMATION RISK AND IMPERFECT MARKETS

Mean-variance efficient portfolio analysis is applied to situations where not all assets are perfectly price elastic in demand nor are asset moments known with certainty. Estimation and solution of such a model are based on an agricultural banking example. The distinction and advantages of a Bayesian formulation over a classical statistical approach are considered. For maximizing expected utility subject to a linear demand curve, a negative exponential utility function gives a mathematical programming problem with a quartic term. Thus, standard quadratic programming solutions are not optimal. Empirical results show important differences between classical and Bayesian approaches for portfolio composition, expected return and measures of risk.Agricultural Finance, Research Methods/ Statistical Methods,

Dynamic Consumption and Portfolio Choice with Ambiguity about Stochastic Volatility

We introduce ambiguity about the variance of the risky asset's return in the model of Chacko and Viceira (2005) for dynamic consumption and portfolio choice with stochastic variance. We find that, with investors being able to update their portfolio continuously (as a function of the instantaneous variance), ambiguity has no impact. To shed some light on the case in which continuous portfolio updating is not possible, we also evaluate the effect of ambiguity when investors must use their expectation of future variance for their portfolio decision. In the latter scenario, demand for the risky asset can be decomposed into three components: myopic and intertemporal hedging demands (as in Chacko and Viceira (2005)) and ambiguity demand. Using long-run US data, Chacko and Viceira (2005) found that intertemporal hedging demand is empirically small, suggesting a low impact of stochastic variance on portfolio choice. Using the same calibration, we find that ambiguity demand may be very high, much more than intertemporal hedging demand. Therefore, stochastic variance can be very relevant for portfolio choice, not because of the variance risk, but because of investors' ambiguity about variance.Asset Allocation, Stochastic Volatility, Ambiguity

Intertemporal Asset Pricing Without Consumption Data

This paper proposes a new way to generalize the insights of static asset pricing theory to a multi-period setting. The paper uses a loglinear approximation to the budget constraint to substitute out consumption from a standard intertemporal asset pricing model. In a homoskedastic lognormal selling, the consumption-wealth ratio is shown to depend on the elasticity of intertemporal substitution in consumption, while asset risk premia are determined by the coefficient of relative risk aversion. Risk premia are related to the covariances of asset returns with the market return and with news about the discounted value of all future market returns.

A Multivariate Model of Strategic Asset Allocation

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.

A Portfolio Approach for the New Zealand Multi-Species Fisheries Management

Marine species are reproducible resource. Maintaining the stock level of marine species and the sustainability of fisheries development become critical issues in current scientific research areas due to the explosion of human population and exacerbation of natural environment. The traditional method that protects the marine species is the single species approach which set maximum sustainable yield (MSY) to prevent over-harvest. However, with the development of technology and comprehension of marine science, the single species approach has been found obsolete and incapable of dealing with problems of severe depletion of fish stocks and escalation of fisheries confliction. Studies show that when regulations are species specific and species are part of a multi-species fisheries, the catch levels of different species are correlated which result in correlation of net return from each species. This paper employ financial portfolio into fisheries, treat fish stocks as assets, model the fishers’ behaviour who face multiple targeting options to predict the optimal targeting strategies. This methodology is applied to New Zealand fisheries that are managed in Quota Management System (QMS) introduced in 1986. Species considered in this research are selected carefully based on two criteria. Efficient risk-return frontier will be generated that provides a combination of optimal strategies. Comparison between results and actual data will be presented. Potential explanations will be given so that further suggestions to fisheries can be made.Agribusiness, Environmental Economics and Policy, Production Economics, Productivity Analysis, Risk and Uncertainty,

An alternative unifying measure of welfare gains from risk-sharing

Following Lucas's (1987) standard approach, welfare gains from international risk-sharing have been measured as the percentage increase in consumption levels that leaves individuals indifferent between, autarky and risk-sharing. The author proposes to measure welfare gains as the increase in consumption growth, instead of consumption levels. When the consumption process is non-stationary, the author's proposed measure has several attractive features: it does not depend on the horizon, and it is robust to alternative specifications of the consumption stochastic processes (from geometric Brownian processes, to Orstein-Ulhenbeck mean-reverting processes), and preferences (from constant relative risk aversion preferences to Kreps-Porteus preferences). The author then uses this measure to estimate potential welfare gains from international risk-sharing for a representative U.S. consumer. The author finds that if international risk-sharing leads only to a complete elimination of aggregate consumption volatility (with no impact on consumption growth), it represents gains to a U.S. consumer of only $12 a year on average. But if international risk-sharing also permits an increase in consumption growth, it may have a sizable impact on welfare. Each 0.5 percentage point increase in consumption growth, represents gains to a U.S. consumer of about$ 160 a year on average.Consumption,Financial Intermediation,Economic Theory&Research,Environmental Economics&Policies,Insurance&Risk Mitigation,Economic Theory&Research,Environmental Economics&Policies,TF054105-DONOR FUNDED OPERATION ADMINISTRATION FEE INCOME AND EXPENSE ACCOUNT,Inequality,Financial Intermediation

The Stochastic Discount Factor: Extending the Volatility Bound and a New Approach to Portfolio Selection with Higher-Order Moments

The authors extend the well-known Hansen and Jagannathan (HJ) volatility bound. HJ characterize the lower bound on the volatility of any admissible stochastic discount factor (SDF) that prices correctly a set of primitive asset returns. The authors characterize this lower bound for any admissible SDF that prices correctly both primitive asset returns and quadratic payoffs of the same primitive assets. In particular, they aim at pricing derivatives whose payoffs are defined as non-linear functions of the underlying asset payoffs. The authors construct a new volatility surface frontier in a three-dimensional space by considering not only the expected asset payoffs and variances, but also asset skewness. The intuition behind the authors' portfolio selection is motivated by the duality between the HJ mean-variance frontier and the Markowitz mean-variance portfolio frontier. The authors' approach consists of minimizing the portfolio risk subject not only to portfolio cost and expected return, as usual, but also subject to an additional constraint that depends on the portfolio skewness. In this sense, the authors shed light on portfolio selection when asset returns exhibit skewness.Financial markets; Market structure and pricing

Two-moment decision model for location-scale family with background asset

This paper studies the impact of background risk on the indifference curve. We first study the shape of the indifference curves for the investment with background risk for risk averters, risk seekers, and risk-neutral investors. Thereafter, we study the comparative statics of the change in the shapes of the indifference curves when the means and the standard deviations of the returns of the financial asset and/or the background asset change. In addition, we draw inference on risk vulnerability and investment decisions in financial crises and bull and bear markets