Abstract
This paper analyses the intertemporal hedging demand for stocks and bonds in South Africa, the United Kingdom and the United States. The analysis is done using an approximate solution method for the optimal consumption and wealth portfolio problem of an infinitely long-lived investor. Investors are assumed to have Epstein-Zin-Weil-type preferences and face asset returns described by a first-order vector autoregression in returns and state variables. The results show that the mean intertemporal hedging demands for stocks are considerably smaller in SA than in the UK or the US, whilst the mean intertemporal hedging demand for bonds are not significantly different from zero in any of the countries considered. Furthermore, it is found that stocks in the US and the UK do not present a useful hedging opportunity for an investor in SA, nor do SA stocks present a useful hedging opportunity for investors from the UK or the US.
Highlights
During the past two decades, a number of studies have focussed on hedging demand and the role it plays in portfolio allocation, for example Campbell and Viceira (1999, 2001), Campbell, Chan and Viceira (2003), Lynch (2001), Su and Lau (2010), Ang, Papanikolaou, Westerfield (2013)
Return predictability and its implications for hedging demands for stocks, bonds and bills is investigated for infinite-horizon investors with Epstein-Zin-Weil preferences in South Africa (SA), the United Kingdom (UK) and the United States (US)
The results indicate that differences in return predictability across countries can lead to significant differences in the implied intertemporal hedging demand for domestic stocks and bonds in different countries
Summary
During the past two decades, a number of studies have focussed on hedging demand and the role it plays in portfolio allocation, for example Campbell and Viceira (1999, 2001), Campbell, Chan and Viceira (2003), Lynch (2001), Su and Lau (2010), Ang, Papanikolaou, Westerfield (2013). In this paper the intertemporal hedging demand for an investor in SA is analysed, in addition to investors in the United Kingdom (UK) and the US. The purpose of this paper is to calculate the implied optimal demand of an infinitely‐lived investor for financial assets in SA, including the myopic and intertemporal hedging components for domestic bills, bonds and stocks by using the approach of Campbell et al (2003) ( CCV). Following Rapach and Wohar (2009) ( RW), the optimal asset demands for an investor in SA who, in addition to domestic financial assets, has access to foreign stocks and bonds (i.e. assets from the UK and the US) is estimated. The optimal asset allocation for investors in the UK and the US who have access to SA stocks and bonds is calculated. The financial crisis is included in the sampling period
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