lecture note - Strategic Asset Allocation: Portfolio Choice...

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1 Strategic Asset Allocation: Portfolio Choice for Long-Term Investors Invited address to the American Economic Association and American Finance Association Atlanta, Georgia, January 4, 2002 John Y. Campbell Harvard University and Arrowstreet Capital, LP It’s a great honor to be asked to give this lunch talk, and particularly to be introduced by Bob Shiller. I well remember when I first read a paper of Bob’s – I was sitting in the New Haven train station during my third year as a Yale PhD student. Bob’s paper on stock market volatility was so absorbing that I lost consciousness of my rather grimy surroundings and had to run frantically to catch my train. I remember thinking that this was the kind of work I would like to be able to do. By great good fortune, Bob later came to Yale and became my thesis adviser, coauthor, and the inspiration for much of my other research. I’d like to talk today about my recent work on strategic asset allocation, the theory of portfolio choice for long-term investors. My book on this subject, written with Luis Viceira, has just been published by Oxford University Press who, I’m glad to see, are aggressively advertising it at this meeting. Normative economics In the book, Viceira and I make specific assumptions about investors’ preferences and the financial market conditions they face. We solve for optimal portfolios under these assumptions, and present these portfolios as investment advice for long-term investors. We do not assume that investors have already chosen optimal portfolios, and thus we do not test our models by comparing our recommended portfolios with actual portfolios. The book is an exercise in normative economics rather than positive economics. Normative economics has a somewhat precarious status in our profession. Most economists prefer to assume that individuals are already optimizing correctly, and that our job is merely to describe their choices. My colleague Robert Barro expressed this view with characteristic sharpness when he told me that “normative economics is what you call your model when it fails to fit the data”. On the other hand, there has always been a desire among economists to use our discipline to improve the world. This is only possible if some agents in the economy – private individuals, government bureaucrats, or politicians – are not already optimizing correctly. Keynes vividly expressed our desire to be useful in his essay “Economic Possibilities for our Grandchildren”. He wrote: “If economists could manage to get themselves thought of as humble, competent people, on a level with dentists, that would be splendid!”
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2 For most of the 20 th Century, economists concentrated on improving the decisions of government policymakers. Keynes may have imagined Treasury and central bank officials as orthodontists, intervening with the painful but effective tools of fiscal and monetary policy. But today, dentists spend much of their time giving advice on oral hygiene.
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This note was uploaded on 01/25/2012 for the course FINS 5510 taught by Professor Kingsleyfong during the Three '11 term at University of New South Wales.

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lecture note - Strategic Asset Allocation: Portfolio Choice...

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