An Investment Strategy Based on Life and Business Cycles

Abstract

This study develops an investment strategy that considers both the life cycle and the business cycle by investing in the market index of emerging and global markets (called the Business and Life Cycle Fund (BLCF)). Considering the change in investors’ risk capacity depending on their age, we propose a model similar to the Target Date Fund (TDF), that incorporates the life cycle. We also incorporate the business cycle into the model for excess returns, which leads the model to invest more in emerging markets during economic booms and to shift the portfolio’s weight to the global market during recessions. To mitigate market risk, we include additional assets that move in an opposite direction to business cycles. The resulting model provides higher annual returns and a higher Sharpe ratio than does the model that encompasses only the life cycle model and other market indices individually. In addition, a model that considers risk hedging shows higher annual returns and a higher Sharpe ratio than does the model encompassing only the business and life cycles. These results contribute to future TDF modeling as well as to Korean policymakers’ default option decision issue. Key words: TDF; BLCF; Business Cycle; Business Reversible Assets; Default Options JEL Classification: G1