Mixed-asset portfolio allocation under mean-reverting asset returns (Q2288891)

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Mixed-asset portfolio allocation under mean-reverting asset returns
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    Mixed-asset portfolio allocation under mean-reverting asset returns (English)
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    20 January 2020
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    In this paper, a portfolio optimization problem is addressed in the presence of real estate investment opportunities. In the financial literature, it is widely acknowledged that real estate assets can represent valuable tools for portfolio diversification. However, it is empirically observed that institutional investors invest in real estate assets around 7--8\% of their wealth. This proportion seems to be significantly lower than what predicted by investment theory, which suggests investing in real estate assets in a proportion of 15--20\% of the total wealth. The portfolio problem considered in this paper includes four basic asset classes: a money market account, a bond with fixed maturity, a real estate asset and a financial stock index. The optimality criterion is represented by the expected utility of terminal wealth, for logarithmic, CARA and CRRA preferences. Investment strategies are dynamic, the market is assumed to be complete and the portfolio optimization problem is solved via the martingale method. The model incorporates time-varying volatilities and expected excess returns. Under these assumptions, it is shown that the portfolio allocation is coherent with the empirical observations. The investment horizon also plays a relevant role: the longer the investment horizon, the larger the proportion of real estate assets. Moreover, the results of the paper justify why in a context of low interest rate environment the real estate allocation may increase as it allows capturing de-correlation and liquidity premiums.
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    portfolio allocation
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    mixed-asset
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    real estate investment
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    mean reverting effects
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