Essays on Dynamic Asset Allocation and Performance Measures

The present thesis examines two central issues in financial theory, optimal portfolio
choice and investment performance evaluation, when the restrictive assumptions of
the traditional static, mean-variance framework of analysis are relaxed.
Chapter 2 presents a series of model specifications for the risky asset's returns and
the underlying risk factor and derives the corresponding optimal portfolio choices. It
shows how important the modelling assumptions are for the implementation of dynamic
asset allocation in practice and it contributes to the literature by examining
the impact of horizon effects on portfolio choice in the presence of both predictability
and stochastic volatility in asset returns. Moreover, this chapter shows how important
is the introduction of an asset that completes the market and allows investors
to hedge against the shocks that affect their opportunity set,
Chapter 3 examines the bond portfolio choice of a long-term investor, making use
of a macro-finance term structure model that allows for time-varying risk premia.
This chapter shows how important is the failure of the expectations hypothesis for
both myopic and long-term investors, since the time-variation in the bond premia
dictates a market timing behaviour for investment as well as for hedging purposes.
Incorporating macroeconomic information, that plays a significant role in bond pricing,
we examine how this can be used for the formation of optimal portfolios· by
long-term investors. Furthermore, this chapter serves as an evaluation of the very recent term structure models from an asset allocation perspective, drawing the attention
to the correlation and the covariance structure of the bond returns. '
Chapter 4 employs the Harvey-Siddique asset pricing model and 'evaluates a sample
of UK equity unit trusts, proposing the intercept of this model, that is termed as
the Harvey-Siddique alpha, as a new performance measure. This asset pricing model
adds to the CAPM the returns of a negative coskewness strategy as an extra risk
factor. Constructing this factor for the UK stock market, it is shown that negative
coskewness bears a high risk premium. This framework allows us to examine how
the adoption of specific performance measures generates incentives in fund management.
In particular, we provide evidence that fund managers, who are evaluated by
mean-variance performance measures, are incentivized to load negative coskewness
risk to their portfolios in order to reap the corresponding premium and present it as
outperformance.
Chapter 5 overviews the contributions of this thesis, discusses the numerous issues
that arise from the present results and outlines the following steps in our research
agenda.