Long memory and the term structure of risk

This paper focuses on the implications of asset return predictability on long-term portfolio choice when return forecasting variables exhibit long memory. Recent research in empirical finance argues that expected asset returns are time-varying and relates them to various predicting variables that historically reveal very gradualmovements in time; hence, we aim at careful modelling of their persistence properties. For that purpose, we exploit the class of fractionally integrated processes. Our theoretical derivations indicate profound impact of the long-memory component on optimal long-term portfolio weights. We illustrate our approach to the modelling ofasset return dynamics on post-war US data for equities, Treasury bonds, and cash.

Netspar, Network for Studies on Pensions, Aging and Retirement, is een denktank en kennisnetwerk. Netspar is gericht op een goed geïnformeerd pensioendebat.


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