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STRATEGIC ASSET ALLOCATION FOR LONG‐TERM INVESTORS: PARAMETER UNCERTAINTY AND PRIOR INFORMATION
Author(s) -
Hoevenaars Roy P. P. M.,
Molenaar Roderick D. J.,
Schotman Peter C.,
Steenkamp Tom B. M.
Publication year - 2013
Publication title -
journal of applied econometrics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 2.878
H-Index - 99
eISSN - 1099-1255
pISSN - 0883-7252
DOI - 10.1002/jae.2331
Subject(s) - econometrics , bond , asset allocation , economics , prior probability , bayesian probability , term (time) , equity (law) , asset (computer security) , bayesian vector autoregression , financial economics , statistics , finance , mathematics , portfolio , computer science , physics , computer security , quantum mechanics , political science , law
SUMMARY We study the effect of parameter uncertainty on the long‐run risk for three asset classes: stocks, bills and bonds. Using a Bayesian vector autoregression with an uninformative prior we find that parameter uncertainty raises the annualized long‐run volatilities of all three asset classes proportionally with the same factor relative to volatilities that are conditional on maximum likelihood parameter estimates. As a result, the horizon effect in optimal asset allocations is much weaker compared to models in which only equity returns are subject to parameter uncertainty. Results are sensitive to alternative informative priors, but generally the term structure of risk for stocks and bonds is relatively flat for investment horizons up to 15 years. Copyright © 2013 John Wiley & Sons, Ltd.