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Portfolio Advice for a Multifactor World

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  • John H. Cochrane

Abstract

Asset returns, it turns out, do not follow the Capital Asset Pricing Model, and are somewhat predictable over time. I survey and interpret the large body of recent work that adapts traditional portfolio theory to answer, what should an investor do about these new facts in finance? I survey the extension of the famous 2 - fund' theorem to an N-fund'' theorem in which investors either hedge or assume the additional, non-market, sources of priced risk; I survey the burgeoning literature on time-varying portfolio rules and the Bayesian literature that advocates a great deal of caution. In a survey, I emphasize the risk-sharing nature of asset markets, I note the likelihood that many supposed anomalies will not last, and I emphasize the fact that the average investor must hold the market so portfolio decisions must be driven by differences between an investor and the average investor.

Suggested Citation

  • John H. Cochrane, 1999. "Portfolio Advice for a Multifactor World," NBER Working Papers 7170, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:7170
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    References listed on IDEAS

    as
    1. John H. Cochrane, 1997. "Where is the market going? Uncertain facts and novel theories," Economic Perspectives, Federal Reserve Bank of Chicago, vol. 21(Nov), pages 3-37.
    2. Kandel, Shmuel & Stambaugh, Robert F, 1996. "On the Predictability of Stock Returns: An Asset-Allocation Perspective," Journal of Finance, American Finance Association, vol. 51(2), pages 385-424, June.
    3. Brennan, Michael J. & Schwartz, Eduardo S. & Lagnado, Ronald, 1997. "Strategic asset allocation," Journal of Economic Dynamics and Control, Elsevier, vol. 21(8-9), pages 1377-1403, June.
    4. John Y. Campbell & John Cochrane, 1999. "Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Journal of Political Economy, University of Chicago Press, vol. 107(2), pages 205-251, April.
    5. David Hirshleifer, 2001. "Investor Psychology and Asset Pricing," Journal of Finance, American Finance Association, vol. 56(4), pages 1533-1597, August.
    6. Merton, Robert C., 1971. "Optimum consumption and portfolio rules in a continuous-time model," Journal of Economic Theory, Elsevier, vol. 3(4), pages 373-413, December.
    7. Paul A. Samuelson, 2011. "Lifetime Portfolio Selection by Dynamic Stochastic Programming," World Scientific Book Chapters, in: Leonard C MacLean & Edward O Thorp & William T Ziemba (ed.), THE KELLY CAPITAL GROWTH INVESTMENT CRITERION THEORY and PRACTICE, chapter 31, pages 465-472, World Scientific Publishing Co. Pte. Ltd..
    8. Kim, Tong Suk & Omberg, Edward, 1996. "Dynamic Nonmyopic Portfolio Behavior," The Review of Financial Studies, Society for Financial Studies, vol. 9(1), pages 141-161.
    9. Gallant, A. Ronald & Hansen, Lars Peter & Tauchen, George, 1990. "Using conditional moments of asset payoffs to infer the volatility of intertemporal marginal rates of substitution," Journal of Econometrics, Elsevier, vol. 45(1-2), pages 141-179.
    10. Lakonishok, Josef & Shleifer, Andrei & Vishny, Robert W, 1994. "Contrarian Investment, Extrapolation, and Risk," Journal of Finance, American Finance Association, vol. 49(5), pages 1541-1578, December.
    11. Michael W. Brandt, 1999. "Estimating Portfolio and Consumption Choice: A Conditional Euler Equations Approach," Journal of Finance, American Finance Association, vol. 54(5), pages 1609-1645, October.
    12. LuisM. Viceira & John Y. Campbell, 2001. "Who Should Buy Long-Term Bonds?," American Economic Review, American Economic Association, vol. 91(1), pages 99-127, March.
    13. Fama, Eugene F. & French, Kenneth R., 1989. "Business conditions and expected returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 25(1), pages 23-49, November.
    14. John Y. Campbell & Luis M. Viceira, 1999. "Consumption and Portfolio Decisions when Expected Returns are Time Varying," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 114(2), pages 433-495.
    15. Merton, Robert C, 1969. "Lifetime Portfolio Selection under Uncertainty: The Continuous-Time Case," The Review of Economics and Statistics, MIT Press, vol. 51(3), pages 247-257, August.
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    Full references (including those not matched with items on IDEAS)

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    • G00 - Financial Economics - - General - - - General

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