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Investing for the long run when expected equity premium is nonnegative

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  • Zhang, Yugui
  • Zhu, Jie
  • Zhu, Xiaoneng

Abstract

Barberis (2000) demonstrates that estimation risk plays an important role in long-run asset allocation. After incorporating estimation risk, he finds that predictability in returns makes investors allocate substantially more to stocks in the long run than in the short run. We show that, when the nonnegative equity premium (NEP) condition is imposed on predictive regressions, investors actually allocate roughly the same or less to stocks in the long run. The reason is that the NEP reduces mean reversion in returns by providing informative prior beliefs. A long-horizon investor who ignores reduction in mean reversion may overallocate to stocks by a sizeable amount.

Suggested Citation

  • Zhang, Yugui & Zhu, Jie & Zhu, Xiaoneng, 2020. "Investing for the long run when expected equity premium is nonnegative," Pacific-Basin Finance Journal, Elsevier, vol. 63(C).
    • Handle: RePEc:eee:pacfin:v:63:y:2020:i:c:s0927538x20302274
    DOI: 10.1016/j.pacfin.2020.101397
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    References listed on IDEAS

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    More about this item

    Keywords

    Asset allocation; Long horizon; Economic constraints; Equity premium; Estimation risk;
    All these keywords.

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes

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