A New Perspective on Asset Allocation - download pdf or read online

By Martin L. Leibowitz

ISBN-10: 094320500X

ISBN-13: 9780943205007

Publication by means of Leibowitz, Martin L.

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Figure 32 shows total returns from January 1, 1980, through July 1, 1986, for the S&P 500 Index and for the Salomon Brothers BIG Index as a proxy for the bond market, and also shows the combined returns from a portfolio invested 60 percent in the S&P 500 and 40 percent in the BIG Index. The bond market and stock market returns suggest some degree of co-movement. 40. 34 was found to represent the average value of monthly, bondlstock returns for the period January 6980 through November 1985. Such a correlation of equities with bond market returns suggested Asset Returns and Total Portfolio Duration A New Perspecliz~eon Asset Allocation that a similar correlation must exist between equities and interest-rate movements.

First, for this period in particular, stock market behavior was frequently assumed to be driven largely by changes in interest rates. Second, prior academic work based on dividend discount models bad concluded that stocks had very long duration-20, 30, 40, and even 50 years1 Subsequent work exploring the stock market durations associated with a wide range of sectors and time periods, using a variety of techniques for filtering interest-rate movements, produced a wide 'This author is himself guilty of having reached an essentially similar con(~ Stock Retinrns, Salornon clusion in an earlier study.

When the total portfolio duration matches the liability duration, the surplus function is immunized with respect to interest-rate movements. Higher or lower total portfolio durations would entail different risk exposures to interest-rate changes. Portfolio Optimization The surplus function approach may be used to develop expected values of return as well as measures of both interest-rate and market variability. With this quantification, the asset allocation problem may be formulated as an optimization problem, aimed at achieving the desired balance between return and risk as measured through the fund's surplus values.

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A New Perspective on Asset Allocation by Martin L. Leibowitz


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