Momentum and Mean-Reversion in Strategic Asset Allocation
Abstract:
We study a dynamic asset allocation problem in which stock returns exhibit short-run momentum and long-run mean reversion. We develop a tractable continuous-time model that captures these two predictability features and derive the optimal investment strategy in closed-form. The model predicts negative hedging demands for medium-term investors, and an allocation to stocks that is non-monotonic in the investor's horizon. Momentum substantially increases the economic value of hedging time-variation in investment opportunities. These utility gains are preserved when we impose realistic borrowing and short-sales constraints and allow the investor to trade on a monthly frequency.
Source: Koijen, Ralph S. J., Rodriguez, Juan Carlos and Sbuelz, Alessandro, Momentum and Mean-Reversion in Strategic Asset Allocation (January 27, 2009). EFA 2006 Zurich Meetings. Available at SSRN: http://ssrn.com/abstract=687205
Keywords: Return predictability, Momentum, Mean reversion, Portfolio choice
