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Momentum and Mean Reversion in Strategic Asset Allocation

Author

Listed:
  • Ralph S. J. Koijen

    (Booth School of Business, University of Chicago, Chicago, Illinois 60637)

  • Juan Carlos Rodríguez

    (Department of Finance, CentER, Tilburg University, 5000 LE, Tilburg, The Netherlands)

  • Alessandro Sbuelz

    (Department of Mathematics, Quantitative Finance, and Econometrics, Catholic University of Milan, 20123 Milan, Italy)

Abstract
We study a dynamic asset allocation problem in which stock returns exhibit short-run momentum and long-run mean reversion. We develop a tractable continuous-time model that captures these two predictability features and derive the optimal investment strategy in closed form. The model predicts negative hedging demands for medium-term investors, and an allocation to stocks that is nonmonotonic in the investor's horizon. Momentum substantially increases the economic value of hedging time variation in investment opportunities. These utility gains are preserved when we impose realistic borrowing and short-sales constraints and allow the investor to trade on a monthly frequency.

Suggested Citation

  • Ralph S. J. Koijen & Juan Carlos Rodríguez & Alessandro Sbuelz, 2009. "Momentum and Mean Reversion in Strategic Asset Allocation," Management Science, INFORMS, vol. 55(7), pages 1199-1213, July.
    • Handle: RePEc:inm:ormnsc:v:55:y:2009:i:7:p:1199-1213
    DOI: 10.1287/mnsc.1090.1006
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    References listed on IDEAS

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