We present a novel approach to dynamic portfolio selection that is as easy to implement as the static Markowitz paradigm. We expand the set of assets to include mechanically managed portfolios and optimize statically in this extended asset space. We consider “conditional” portfolios, which invest in each asset an amount proportional to conditioning variables, and “timing” portfolios, which invest in each asset for a single period and in the risk-free asset for all other periods. The static choice of these managed portfolios represents a dynamic strategy that closely approximates the optimal dynamic strategy for horizons up to 5 years.

After years of relative neglect in academic circles, portfolio choice problems are again at the forefront of financial research. The economic theory underlying an investor’s optimal

We study an investor’s optimal consumption and portfolio choice problem when he confronts with two possibly misspecified submodels of stock returns: one with IID returns and the other with predictability. We adopt a generalized recursive ambiguity model to accommodate the investor’s aversion to model uncertainty. The investor deals with specification doubts by slanting his beliefs about submodels of returns pessimistically, causing his investment strategy to be more conservative than the Bayesian strategy. This effect is large for high and low values of the predictive variable. Unlike in the Bayesian framework, the hedging demand against model uncertainty may cause the investor’s stock allocations to first decrease sharply and then increase with his prior probability of the IID model, even when the expected stock return under the IID model is lower than under the predictability model. Adopting suboptimal investment strategies by ignoring model uncertainty can lead to sizable welfare costs.

This paper studies strategic asset allocation and consumption choice in the presence of regime switching in asset returns. We find evidence that four separate regimes- characterized as crash, slow growth, bull and recovery states- are required to capture the joint distribution of stock and bond returns. Optimal asset allocations vary considerably across these states- both among bonds and stocks and among large and small stocks- and change over time as investors revise their estimates of the underlying state probabilities. In the crash state investors always allocate more of their portfolio to stocks the longer their investment horizon, while the optimal allocation to stocks declines as a function of the investment horizon in bull markets. The joint effects of learning about the underlying state probabilities and predictability of asset returns from the dividend yield give rise to a non-monotonic relationship between the investment horizon and the demand for stocks. Consumption-to-wealth ratios are found to depend on the underlying state and welfare costs from ignoring regime switching are substantial even after accounting for parameter uncertainty. Out-of-sample forecasting experiments confirmtheeconomicimportanceof accounting for the presence of regimes in asset returns. We are grateful to John Campbell for discussion and also thank seminar participants at Caltech, the Innovations in Financial

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Suppose an investor wishes to select assets so as to maximize expected utility of end-of-period wealth and/or consumption over time. The optimal asset allocation decision is of long standing interest to finance scholars and it has direct practical relevance. In a complete market the modern procedure for computing the optimal portfolio weights is known as the martingale approach and it was laid out by Cox and Huang (and other authors). Recently alternative implementations of the martingale approach based on Monte Carlo methods have been proposed. This paper describes one of these methods which involves the numerical computation of stochastic integrals. It is often possible to improve the e#ciency of these computations by using deterministic numbers rather than random numbers. These deterministic numbers are known as quasi random numbers and they are selected so that they are well dispersed throughout the region of interest. The paper implements a method for computing the optimal portfolio weights that exploits a particular feature of quasi random numbers.

1 Human capital investment and portfolio choice over the life-cycle I study a theoretical model of life-cycle portfolio choice for an investor who has an option to invest in human capital but is liquidity constrained. I find that, since the young are more likely to exercise the option than the old, they are more concerned about liquidity risk (i.e. the risk that the liquidity constraint binds when it is optimal to invest). This, in turn, implies a hump-shaped pattern of lifetime risky asset holdings: portfolio share invested in equities is increasing for the young and decreasing for the older agents. Optimal investment rule and the precautionary demand for the riskless asset vary with the business cycle, which suggests potential implications for asset pricing.

The model used in this report focuses on the analysis of ship waiting statistics and stock fluctuations under different arrival processes. However, the basic outline is the same: central to both models are a jetty and accompanying tankfarm facilities belonging to a new chemical plant in the Port of Rotterdam. Both the supply of raw materials and the export of finished products occur through ships loading and unloading at the jetty. Since disruptions in the plants production process are very expensive, buffer stock is needed to allow for variations in ship arrivals and overseas exports through large ships. Ports provide jetty facilities for ships to load and unload their cargo. Since ship delays are costly, terminal operators attempt to minimize their number and duration. Here, simulation has proved to be a very suitable tool. However, in port simulation models, the impact of the arrival process of ships on the model outcomes tends to be underestimated. This article considers three arrival processes: stock-controlled, equidistant per ship type, and Poisson. We assess how their deployment in a port simulation model, based on data from a real case study, affects the efficiency of the loading and unloading process. Poisson, which is the chosen arrival process in many client-oriented simulations, actually performs worst in terms of both ship delays and required storage capacity. Stock-controlled arrivals perform best with regard to ship delays and required storage capacity. In the case study two types of arrival processes were considered. The first type are the so-called stock-controlled arrivals, i.e., ship arrivals are scheduled in such a way, that a base stock level is maintained in the tanks. Given a base stock level of a raw material or ...

We analyze the effect of health cost risk on optimal annuity demand and consumption/savings decisions. Many retirees are exposed to sizeable out-of-pocket medical expenses, while annuities potentially impair the ability to get liquidity to cover these costs and smooth consumption. We find that if out-of-pocket medical expenses can already be very sizeable early in retirement, full annuitization is suboptimal. In other cases, individuals take advantage of the mortality credit annuities provide and save out of the annuity income to build a buffer for health cost shocks at later ages. When comparing to empirically observed levels of annuitization, we find that sizeable health cost risk early in retirement may resolve the annuity puzzle. Moreover, we explain the observed pattern of annuitization as a function of initial wealth at retirement. For personal financial planning purposes, we develop a simple rule of thumb for annuity demand, based on expected health cost risk early in retirement, wealth at retirement, and subsistence consumption levels. We show that the welfare costs from using the rule compared to the life cycle model are small.

We examine incomplete annuity menus and background risk as possible drivers of divergence from full annuitization. Contrary to what is often suggested in the literature, we find that full annuitization remains optimal if saving is possible after retirement. This holds irrespective of whether real or only nominal annuities are available. Whenever liquidity is desired, individuals save sizeable amounts out of their annuity income to smooth consumption shocks. Similarly, adding variable annuities to the menu does not increase welfare significantly, since individuals can save in order to get the desired equity exposure. We calculate bounds on a possible bequest motive and default risk of the annuity provider and find that for realistic parameters