Sustainable Asset Accumulation and Dynamic Portfolio Decisions

203 Pages·2016·7.64 MB·English

by  Carl Chiarella

Dynamic Modeling and Econometrics in
Economics and Finance 18
Carl Chiarella
Willi Semmler
Chih-Ying Hsiao
Lebogang Mateane
Sustainable Asset
Accumulation and
Dynamic Portfolio
Decisions
Dynamic Modeling and Econometrics
in Economics and Finance
Volume 18
Editors
StefanMittnik
LudwigMaximillianUniversityMunich
Munich,Germany
WilliSemmler
BielefeldUniversity
Bielefeld,Germany
and
NewSchoolforSocialResearch
NewYork,USA
Moreinformationaboutthisseriesathttp://www.springer.com/series/5859
Carl Chiarella • Willi Semmler (cid:129) Chih-Ying Hsiao (cid:129)
Lebogang Mateane
Sustainable Asset
Accumulation and Dynamic
Portfolio Decisions
123
CarlChiarella WilliSemmler
SchoolofFinanceandEconomics HenryArnholdProfessorofEconomics
UniversityofTechnology DepartmentofEconomics
Sydney,NewSouthWales,Australia NewSchoolforSocialResearch
NewYork,NY,USA
and
BielefeldUniversity
Bielefeld,Germany
Chih-YingHsiao LebogangMateane
SchoolofFinanceandEconomics DepartmentofEconomics
UniversityofTechnology NewSchoolforSocialResearch
Sydney,NewSouthWales,Australia NewYork,NY,USA
ISSN1566-0419 ISSN2363-8370 (electronic)
DynamicModelingandEconometricsinEconomicsandFinance
ISBN978-3-662-49228-4 ISBN978-3-662-49229-1 (eBook)
DOI10.1007/978-3-662-49229-1
LibraryofCongressControlNumber:2016942551
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Preface
The global economy experienced a worldwide meltdown of asset markets in the
years 2007–2009. This posed great challenges for asset and portfolio managers.
Many fundssuch as university endowments,sovereign wealth funds, and pension
funds were overexposedto risky returns and suffered considerable losses. On the
other hand, the long-run upswing in the stock market since 2010, induced by a
monetary policy of quantitative easing in the USA, and later in Europe and Asia,
ledtoassetpriceboomsandnewwealthformation.Inbothcasesquitesignificant
differencesin asset managementandwealth accumulationwere visible. Our book
aims at dealing with sustainable wealth formation and dynamic decision making.
Wehavethreeperspectivesinmind.
A first perspective is how wealth formation and the proper management of
financial funds can help to buffer income risk sufficiently and to obtain adequate
risk-freeincomeatalaterstageoflife.Thisisanimportantconcerninthecurrent
publicdebateonassetaccumulationandwealthdisparity.Inwhateverinstitutional
formsavingtakesplace,in mutualfunds,publicpensionfunds,corporatepension
funds,orprivatesavingaccounts,thegenericissueishowmuchtosaveandinvest
andhowtomakeproperassetallocationdecisions.
A second important issue for sustainable wealth accumulation is that many
agents and institutions in financial markets tend to put some constraints on the
accumulationandallocationofassets—followingsomerules,guidelinesandrestric-
tions concerning risk-taking, safeness of investments, as well as social, ethical,
environmental, and climate change aspects. Thus investments are often restricted
to certain risk classes, classes of assets or particular assets. Much investment and
assetallocationdecisionsarethereforemadefollowingbehavioralandinstitutional
rules, responding to some given constraints and guidelines, without necessarily
beingoptimalinthenarrowsense.
Athirdperspectiveofsustainablewealthformationisthatwewanttomovemore
towarddynamicdecisionmakinganddynamicre-balancingofportfolios.Portfolio
decisionsarefrequentlymodeledasstaticdecisionsproblems.Yet,howshouldthe
investorsrespondtoexpectedfuturereturns,changingreturndifferentials,globalor
idiosyncraticrisk,changeofinflationrates, affectingtherealvalueoftheirassets,
v
vi Preface
andsoon?Instandardliterature,themodelingofsavingsandwealthaccumulation
areoftenseparatedfromassetallocationdecisions.We pursuea simultaneousand
dynamictreatmentofbothsavingsbehaviorandportfoliodecisionmaking,taking
into account expected returns. Expected returns are evaluated here, using a new
method—harmonicestimationsofreturns.
In order to solve such dynamic decision problems in portfolio theory and
portfolio practice—solving saving as well as asset accumulation problems
simultaneously—weputforwarddynamicprogrammingasaprocedurefordynamic
decisionmakingthatallowstointegratesustainablewealthaccumulationaswellas
asset allocation decisions. Although some shortcomingsof this procedureexist, a
carefuluseofitcanhelptonotonlyundertakedynamicmodelingbutalsoaidonline
decision making once some pattern of expected returns of different asset classes,
forexampleestimatedthroughusingharmonicestimations,hasbeenrecognized.
Thebookiswrittenin awaythatitcanbeusedbyresearchersandin graduate
classes on financial economics, asset pricing and portfolio theory, finance and
macro,portfoliotheoryandpractice,pensionfundtheoryandmanagement,socially
responsibleinvestmentdecisions,financialmarketandwealth disparities,method-
ology of dynamic portfolio theory, intertemporalasset allocation and households’
saving,andapplieddynamicprogramming.
PartsofthebookarebasedonlecturesdeliveredattheUniversityofBielefeld,
Germany, the University of Technology, Sydney, Australia, The New School for
Social Research, New York City, USA, and University of Economics, Vienna,
Austria, as well as conferencesand workshopsat the ZEW, Mannheim,Germany.
We are very grateful to our colleagues at those institutions as well as to several
generations of students who took our classes in this area and gave comments on
these lectures in their formative stages. We are also grateful for discussions with
Hans Amman, Lucas Bernard, Raphaele Chappe, Peter Flaschel, Lars Gruene,
StefanMittnik,UnraNyambuu,EckhardPlaten,andJamesRamsey.
Individually, many of the chapters of the book have been presented at con-
ferences, workshops, and seminars throughout the United States, Europe, and
Australia. Many chapters of this book are also based on previous article by the
authors,publishedwithavarietyofdifferentcoauthors.Eachchapteracknowledges
the particular coauthors involved, and a general acknowledgment can be found
below.
Inpreparingthismanuscript,wein particularreliedonthehelpofTonyBonen
and Uwe Koeller whom we want to thank for extensive assistance in editing this
volume. Willi Semmler wants to thank the Fulbright Foundation for a Fulbright
ProfessorshipattheUniversityofEconomics,Vienna,intheWinterTerm2011,as
wellastheGermanResearchFoundationforfinancialsupport.
Sydney,NSW,Australia CarlChiarella
NewYork,NY,USA WilliSemmler
Sydney,NSW,Australia Chi-YingHsiao
NewYork,NY,USA LebogangMateane
December10,2015
Acknowledgements
The following material and journal articles have been used as foundations for
variouschapters of the book. The chapters have to some extent been reworked in
thelightofnewdevelopmentsintheirsubjectareasandarenotnecessarilyidentical
intheirtitlestotheonesoftheoriginalpapers.Wethanktheeditorsandpublishers
ofthismaterialforthepermissionofreusingitinthisbook.
(cid:129) Chap.4:Semmler,W.,L.GrueneandL.Oehrlein(2009),DynamicConsumption
and Portfolio Decisions with Time Varying Asset Returns, Journal of Wealth
Management,vol.12,no.2.
(cid:129) Chap. 5: Semmler, W. and C-Y. Hsiao (2009), Dynamic Consumption and
PortfolioDecisionswith Low FrequencyMovementsof Asset Returns,Journal
ofWealthManagement,vol14,no2:101-111.
(cid:129) Chap. 6: Semmler, W., ”Dynamic Consumption and Portfolio Decisions with
Estimated Low Frequency Movements of Asset Returns and Labor Income”,
JournalofWealthManagement,vol.14,no2:101-111,2012.
(cid:129) Chap. 7: Some of this material has been published in the edited volume
“Financial Econometrics Modeling – derivatives pricing, hedge fund and term
structuremodels”,MacMillan.
vii

Contents
1 Introduction .................................................................. 1
1.1 Institutions,ModelsandEmpirics...................................... 2
1.2 DynamicProgrammingasSolutionMethod........................... 4
1.3 PreviousWork........................................................... 5
1.4 OutlineandResults ..................................................... 7
2 ForecastingandLowFrequencyMovementsofAssetReturns......... 9
2.1 Introduction ............................................................. 9
2.2 LimitsonForecastingAssetReturns................................... 9
2.3 TheUseofPeriodicReturns............................................ 14
2.4 Conclusions ............................................................. 17
3 PortfolioModelingwithSustainabilityConstraints...................... 19
3.1 Introduction ............................................................. 19
3.2 Mean-VariancePortfolioModels....................................... 21
3.3 DescriptionofStatisticalPropertiesofReturnsData ................. 27
3.3.1 ComputingExpectedRealReturnsonRiskyAssets.......... 27
3.3.2 Variance-CovarianceandCorrelationMatrices
andVolatilityofRealReturns.................................. 30
3.3.3 Eigenvalue and Eigenvector Properties
oftheEmpiricalCovarianceandCorrelationMatrix ......... 33
3.4 EstimationResultsofthePortfolioModels............................ 37
3.5 Conclusion .............................................................. 47
Appendix ...................................................................... 48
4 DynamicSavingandPortfolioDecisions-Theory......................... 53
4.1 Introduction ............................................................. 53
4.2 TheModelwithOneAssetandConstantReturns..................... 53
4.2.1 NumericalResultsfortheBenchmarkModel................. 55
4.2.2 VariationofRiskAversion,ReturnsandDiscountRate...... 57
ix