Multistage risk premiums in portfolio optimization

This study determines optimal portfolios of five major U.S. financial assets based on four performance measures consistent with modern portfolio theory and the Capital Asset Pricing Model, and analyzes their risk-return profiles, over different investment horizons. Intermediate-term government bonds offer the best tradeoff between the risk premium and systematic risk, while small company stocks provide the highest risk premium adjusted for systematic risk, for all investment periods. Diversified portfolios containing mainly intermediate-term government bonds, with smaller allocations to small and large company stocks, generally deliver the best tradeoff between the risk premium and total risk as well as the highest risk premium adjusted for total risk. These diversified optimal portfolios hold declining proportions of intermediate-term government bonds and rising allocations of small and large company stocks, for longer investment horizons. All the optimal portfolios identified by the different performance measures offer substantially better risk-adjusted performance over longer periods. Keywords Performance Measures, Optimal Portfolios, Risk-Return Tradeoff, Investment Horizon

Consumption Decisions under Uncertainty

Jump-Diffusion International Asset Pricing with Nontraded Consumption Goods

The global economic crisis, which resulted in devastating losses to traditional, capital-based asset allocation portfolios, spiked interest in risk-based portfolios. As a result, risk parity strategies have taken off in recent years. Champions of the increasingly popular risk parity strategy maintain that traditional strategies such as 60/40 typically end up unbalanced, with a higher allocation to riskier assets or equities, unlike risk parity strategies, which allocate portfolio risk across asset classes. But are the increasing ranks of so-called risk parity portfolios truly at risk parity? Because risk parity is open to different interpretations, it is difficult for investors to tell the difference between risk allocation approaches, research shows. <i><b>Are Risk Parity Managers at Risk Parity?</b></i>, published in the Fall 2013 issue of <i><b>The Journal of Portfolio Management</b></i>, aims to define risk parity and examines whether a sample of risk parity managers are truly adhering to the risk parity principle. “Risk parity since 2008 on the one hand has become an accepted investment strategy,” <b>Edward Qian</b>, Chief Investment Officer in the Multi-Asset Group at <b>PanAgora Asset Management</b> in Boston says. “As someone who christened the term, I thought there could be misinterpretation.” <b>TOPICS:</b>Portfolio management/multi-asset allocation, factors, risk premia, risk management

This paper develops a dynamic stochastic general equilibrium monetary portfolio choice model that accomplishes two objectives. First, it provides a theory of currency risk premia based on a weak and plausible form of fiscal nonneutrality. Domestic and foreign bonds become imperfect substitutes, the uncovered interest parity condition is replaced with a portfolio balance equation, and the central bank can separately choose the growth rate of its nominal anchor and the domestic bond interest rate. Second, it can then be shown that, and how, sterilized intervention affects equilibrium allocations and prices. The authors thank Guillermo Calvo, Ken Judd, Carmen Reinhart, Ken Rogoff, Tom Sargent, Martin Schneider, Stephen Turnovsky and seminar participants at the IMF, the 2001 LACEA meetings in Uruguay, and Stanford’s Macro lunch group, for helpful comments.

Entrepreneurs face significant non-diversifiable business risks. We build a dynamic incomplete markets model of entrepreneurial finance to demonstrate the important implications of nondiversifiable risks for entrepreneurs' interdependent consumption, portfolio allocation, financing, investment, and business exit decisions. The optimal capital structure is determined by a generalized tradeoff model where leverage via risky non-recourse debt provides significant diversification benefits. More risk-averse entrepreneurs default earlier, but also choose higher leverage, even though leverage makes his equity more risky. Non-diversified entrepreneurs demand both systematic and idiosyncratic risk premium. Cash-out option and external equity further improve diversification and raise the entrepreneur's valuation of the firm. Finally, entrepreneurial risk aversion can overturn the risk-shifting incentives induced by risky debt.

Dynamics of Entrepreneurship Under Incomplete Markets

PurposeThis paper aims to analyze the characteristics of stochastic volatility processes in globally listed private equity (LPE) markets, which are represented by nine global, regional and style indices, and reveals transmissions in the conditional variances between the different markets, based on weekly data covering the period January 2011 to December 2020.Design/methodology/approachThe study uses the generalized autoregressive conditional heteroscedasticity [GARCH(p, q)] model and its exponential GARCH (EGARCH) and GARCH-in-mean extensions.FindingsThe estimates of the volatility models GARCH, EGARCH and GARCH-in-mean GARCH-M for testing the stylized properties persistence, asymmetry, mean reversion and risk premium lead to very different results, depending on the respective LPE index.Practical implicationsThe knowledge of conditional volatilities of LPE returns as well as the detection of volatility transmissions between the different LPE markets under investigation serve to support asset allocation decisions with respect to risk management or portfolio allocation. Hence, the findings are important for all kinds of investors and asset managers who consider investments in LPE.Originality/valueThe authors present a novel study that examines the conditional variance for globally LPE markets by using LPX indices, offering valuable insight into this growing asset class.

The Role of Bond Markets When Portfolio Choice is Constrained

Portfolio choice with stochastic interest rates and learning about stock return predictability

The fundamental PDE for valuing cash flows or cash flow streams is explained. In a complete market, an investor’s optimal wealth satisfies the fundamental PDE, and this provides a means of calculating the optimal portfolio. Risk neutral probabilities and Girsanov’s theorem are explained. Jump processes, including Poisson processes, are introduced. The risk premium of an asset with jump risks depends on covariation of its continuous part with the continuous part of an SDF and the covariation of its discontinuous part with the discontinuous part of an SDF. Portfolio choice with internal habits is characterized. The ability of a representative investor model with an internal habit to explain the equity premium puzzle is discussed.

Tail Risk and Robust Portfolio Decisions

Earning the right premium on the right factor in portfolio planning

Optimal Annuity Risk Management

This research aims to explore the selection and optimization of stocks from two Eastern European markets, Romania and Poland, starting from the maximum return criterion, downside risk, and Sortino ratio when building a portfolio. The Post-Modern Portfolio Theory (PMPT) serves as the main methodological framework to achieve our primary objective, ‘Building portfolios of stocks on the two markets in Eastern Europe, Romania and Poland, starting from the maximum return criterion’. The research focused on stocks from the flagship indexes of the Bucharest Stock Exchange (BSE) and the Warsaw Stock Exchange (WSE), namely the BET Index and the WIG20 Index. The data was collected for 40 companies, 20 companies in each stock market, for the period June 2020 until June 2025, 5 ‘stock years’, with daily close prices, government 10-year bonds as risk-free rates, and equity risk premiums for Romanian and Polish markets. Two portfolios were built, one from the BSE and another from the WSE. The results indicate, through PMPT and Sortino ratio as a performance indicator, that indeed the potential loss of a stock (downside risk) and the expected return play a crucial role in building portfolios, especially in volatile markets.