"Stock Market Mean Reversion And The Optimal Equity Allocation Of
A Long-Lived Investor"
BY: JOHN Y. CAMPBELL
Harvard University
Dept. of Economics
National Bureau of Economic Research (NBER)
JOAO F. COCCO
London Business School
FRANCISCO J. GOMES
London Business School
PASCAL J. MAENHOUT
INSEAD European Institute of Business
Administration
LUIS M. VICEIRA
Harvard Business School
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=237175
Paper ID: Harvard Institute of Economic Research Paper No. 1899
Date: June 2000
Contact: JOHN Y. CAMPBELL
Email: Mailto:john_campbell at harvard.edu
Postal: Harvard University
Dept. of Economics
Room 213
Littauer Center
Cambridge, MA 02138-3001 USA
Phone: 617-496-6448
Fax: 617-495-7730
Co-Auth: JOAO F. COCCO
Email: not available
Postal: London Business School
Sussex Place
Regent's Park
London NW1 4SA, UK
Co-Auth: FRANCISCO J. GOMES
Email: not available
Postal: London Business School
Sussex Place
Regent's Park
London NW1 4SA, UK
Co-Auth: PASCAL J. MAENHOUT
Email: not available
Postal: INSEAD European Institute of Business Administration
Boulevard de Constance
F-77305 Fontainebleau Cedex, FRANCE
Co-Auth: LUIS M. VICEIRA
Email: Mailto:lviceira at hbs.edu
Postal: Harvard Business School
Soldiers Field Road
Boston, MA 02163 USA
ABSTRACT:
This paper solves numerically the intertemporal consumption and
portfolio choice problem of an infinitely-lived investor who
faces a time-varying equity premium. The solutions we obtain are
very similar to the approximate analytical solutions of Campbell
and Viceira (1999), except at the upper extreme of the state
space where both the numerical consumption and portfolio rules
flatten out. We also consider a constrained version of the
problem in which the investor faces borrowing and short-sales
constraints. These constraints bind when the equity premium
moves away from its mean in either direction, and are
particularly severe for risk-tolerant investors. The optimal
constrained portfolio rules are similar but not identical to the
optimal unconstrained rules with the constraints imposed. The
portfolio constraints also affect the optimal consumption
policy.
Keywords: Hedging Demand, Intertemporal Portfolio Choice, And
Mean Reversion