Preview
Develops a theory of long‐term portfolio choice when the real interest rate changes over time, but risk premia and variances and covariances of returns are constant. Conventional short‐term mean‐variance analysis tends to relegate bonds to a minor supporting role in the recommended portfolio, since excess bond returns have historically been fairly low and bond returns have been highly variable in the short run. A long‐horizon analysis treats bonds very differently, and assigns them a much more important role in the optimal portfolio. The riskless asset for a long‐term investor is not a Treasury bill, which must be rolled over at uncertain future real interest rates, but a long‐term inflation‐indexed bond, which delivers a predictable stream of real income and thus supports a stable standard of living in the long term. Conservative long‐term investors should tilt their portfolios towards inflation‐indexed bonds, or nominal bonds if inflation risk is low, rather than towards cash as predicted by the standard short‐term analysis.
Keywords: bonds; inflation risk; inflation‐indexed bond; interest rates; portfolio choice; riskless asset; term structure
Chapter. 14356 words. Illustrated.
Subjects: Financial Markets
Go to Oxford Scholarship Online » abstract
Full text: subscription required
How to subscribe Recommend to my Librarian
Buy this work at Oxford University Press »
Users without a subscription are not able to see the full content. Please, subscribe or login to access all content.