Strategic Asset Allocation with Arbitrage-Free Bond Market using Dynamic Programming

Recently, Campbell and Viceira (2002) have introduced an intertemporal framework for asset allocation problem where the interest rate and the asset price dynamics are varying with the time. This paper follows up their work and try to explain the asset allocation puzzle of Canner, Mankiw and Weil(1997). We consider the bond prices systematically by integrating the no-arbitrage bond pricing models in the intertemporal framework. We employ the method of Dynamic Programming to solve the intertemporal consumption and portfolio decisions numerically because usually this intertemporal decision problems cannot be solved analytically. The numerical example considers the Vasicek bond price and the Markowitz stock price. Various properties of the consumption and portfolio decisions will be demonstrated in the numerical example. Our numerical results can explain the asset allocation puzzle. JEL Classification: G11(Portfolio Choice), C61(Optimization Techniques). Center of Empirical Macroeconomics(CEM) University Bielefeld, Germany School of Finance and Economics, University of Technology, Sydney, Australia Center of Empirical Macroeonomics(CEM), University Bielefeld and New School University, New York