Scandinavian Working Papers in Economics

Working Papers,
Copenhagen Business School, Department of Finance

No 2001-6: Portfolio Choice under Inflation: Are Popular Recommendations Consistent with Rational Behavior?

Claus Munk , Carsten Sørensen and Tina Nygaard Vinther
Additional contact information
Claus Munk: University of Southern Denmark, Postal: Dept. of Accounting, Finance & Law, University of Southern Denmark
Carsten Sørensen: Department of Finance, Copenhagen Business School, Postal: Department of Finance, Copenhagen Business School, Solbjerg Plads 3, A5, DK-2000 Frederiksberg, Denmark
Tina Nygaard Vinther: SimCorp Danmark A/S, Postal: SimCorp Danmark A/S

Abstract: We consider the optimal asset allocation choice of an investor who can invest in cash (a money market bank account), nominal bonds, and stocks (the stock index). The investor faces an incomplete market setting and is not able to perfectly hedge long run real interest rate risk using the available securities. The optimal invest- ment strategy is consistent with the following features of popular investment advice which have been pointed out as puzzles: (i) a decreasing fraction of stocks in the portfolio as time passes towards the investment horizon, and (ii) a higher bond to stock ratio for more conservative (less risk tolerant) investors (Canner, Mankiw and Weil, 1997). The model for asset price dynamics is calibrated to US market data and, furthermore, risk aversion parameters and time horizons are calibrated so as to obtain a match between the optimal asset allocations and observed investment recommendations for \aggressive," \moderate," and \conservative" investor groups with di®erent investment horizons.

Keywords: Investment; Nominal bonds; Stocks; Market setting; Securities; Investment strategy; Risk

JEL-codes: G00; G10; G30

23 pages, December 1, 2001

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