Intertemporal portfolio allocation and hedging demand: an application to South Africa

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.

Keyword : intertemporal hedging demand, multi-period portfolio choice, return predictability, South Africa, portfolio allocation, financial markents