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Portfolio Choice and Asset Allocation of Households and Long-Term Investors

Paper Session

Sunday, Jan. 7, 2018 10:15 AM - 12:15 PM

Loews Philadelphia, Regency Ballroom C2
Hosted By: American Finance Association
  • Chair: Thomas Gilbert, University of Washington

Shifts in Sectoral Wealth Shares and Risk Premia: What Explains Them?

Ravi Bansal
,
Duke University
Colin Ward
,
University of Minnesota
Amir Yaron
,
University of Pennsylvania

Abstract

We empirically show across several broad asset classes that sectoral wealth shares do not positively correlate with their risk premia---a first-order prediction of canonical equilibrium models. We then analyze the roles mean-variance and hedging demand play in accounting for sectoral shifts within a two-sector production economy that features imperfect substitutability across goods and demand shocks. With these two features, the model's performance improves, yet still unsatisfactorily accounts for sectoral shifts in wealth shares. We argue that equilibrium models thus face a challenge to explain the cross-sectional evolution of wealth shares and investors' incentives to hold them over time.

Global Portfolio Diversification for Long-horizon Investors

Luis Viceira
,
Harvard Business School
Zihuan Wang
,
Harvard Business School
John Zhou
,
Harvard University

Abstract

This paper conducts a theoretical and empirical investigation of the risk of globally diversified portfolios of stocks and bonds and of optimal intertemporal global portfolio choice for long horizon investors in the presence of permanent cash flow shocks and transitory discount rate shocks to asset values. An increase in the cross-country correlations of cash flow shocks raises the risk of a globally diversified portfolio at all horizons. By contrast, an increase in the cross-country correlations of discount rate shocks has a much more muted effect on portfolio risk at long horizons, suggesting that the benefits of global portfolio diversification to long-term investors do not recede when the source of increased global return correlations is correlated discount rates. Empirically, we document a secular increase in the cross-country correlations of both stock returns and government bond returns since the late 1990's. We identify increased correlations of discount rate shocks resulting from financial globalization as the main driver of the upward shift in stock return correlations. We also identify increased correlations of inflation shocks as an equally important source of the upward shift in bond correlations. By contrast, we don't find evidence of a secular shift in the cross-country correlations of stock market volatility shocks, which have remained fairly low through time except during the financial crisis of 2009.

Agency in Public Pension Performance

I. J. Alexander Dyck
,
University of Toronto
Paulo Manoel
,
University of California-Berkeley
Adair Morse
,
University of California-Berkeley
Lukasz Pomorski
,
AQR Capital Management, LLC

Abstract

PBecause public funds are political organizations, their board members are particularly sensitive to outrage over high compensation of investment managers. High inequality between finance salaries and that of local workers raises the possibility that public funds will not contract for the highest quality managers. We model public pension boards' hiring and compensating of investment managers to achieve optimal portfolios for constituents in the presence of this and other political frictions. We then test the model in global data covering $5.6 trillion in assets. When we estimate a system of compensation and returns equations, we find that one standard deviation lower outrage coming from more local workers and public finance administrators on the board results in $80,000 more in manager compensation. In turn, we find significant excess returns from relaxing outrage constraints leads to a value add of $14-20 million per year for an average public fund, driven by 16-22 basis points excess performance in alternatives and 9-12 basis points in public equities. We confirm the prior politicization results in the literature and show that our outrage effect is orthogonal to underfunding and political pay-to-play results.

Limited Marital Commitment and Household Portfolios

Jawad Addoum
,
Cornell University
Howard Kung
,
London Business School
Gonzalo Morales
,
University of Alberta

Abstract

This paper examines the link between marital decisions, consumption, and optimal portfolio choice in a life-cycle model with limited marital commitment. Without full commitment, individual income shocks lead to renegotiation between spouses, altering relative bargaining power and endogenously generating time-varying risk aversion at the household-level. Consequently, changes in relative income are associated with significant shifts in household portfolios. We find strong support for this prediction using data from the PSID. The model can also rationalize the link between marital transitions and portfolio allocations observed in the data. Finally, the risk-sharing benefits of marriage imply a positive link between wealth and risky asset holdings across households.
Discussant(s)
Jules van Binsbergen
,
University of Pennsylvania
Christian Lundblad
,
University of North Carolina-Chapel Hill
Joshua Rauh
,
Stanford University
Clemens Sialm
,
University of Texas-Austin and NBER
JEL Classifications
  • G1 - General Financial Markets