Dynamic mean-variance asset allocation

Review of Financial Studies

Finance

Review of Financial Studies 2010 Vol 23:8 p 2970-3016

Basak S;Chabakauri G

Suleyman Basak

2010

We solve the dynamic mean-variance portfolio problem and derive its time-consistent solution using dynamic programming. Previous literature, in contrast, only determines either myopic or precommitment (committing to follow the initially optimal policy) solutions. We provide a fully analytical simple characterization of the dynamically optimal mean-variance portfolios within a general incomplete-market economy. We also identify a probability measure that incorporates intertemporal hedging demands and facilitates tractability. We illustrate this by easily computing portfolios explicitly under various stochastic investment opportunities. A calibration exercise shows that the mean-variance hedging demands are economically significant.

This article previously appeared in the IFA Working Paper Series FIN 484

Institute of Finance and Accounting

No