The Journal of Finance

A General Equilibrium Model of International Portfolio Choice

Published: 06/01/1993   |   DOI: 10.1111/j.1540-6261.1993.tb04726.x

RAMAN UPPAL

We investigate, in a two‐country general equilibrium model, whether a bias in consumption towards domestic goods will necessarily lead to a preference for domestic securities. We develop a model where investors are constrained to consume only from their domestic capital stock and where it is costly to transfer capital across countries. In this model, investors less risk averse than an investor with log utility bias their portfolios towards domestic assets. Investors more risk averse than log, however, prefer foreign assets. Thus, this model suggests that it is unlikely that the portfolios observed empirically can be explained by the high proportion of domestic goods in total consumption.

Model Misspecification and Underdiversification

Published: 11/07/2003   |   DOI: 10.1046/j.1540-6261.2003.00612.x

Raman Uppal, Tan Wang

In this paper, we study intertemporal portfolio choice when an investor accounts explicitly for model misspecification. We develop a framework that allows for ambiguity about not just the joint distribution of returns for all stocks in the portfolio, but also for different levels of ambiguity for the marginal distribution of returns for any subset of these stocks. We find that when the overall ambiguity about the joint distribution of returns is high, then small differences in ambiguity for the marginal return distribution will result in a portfolio that is significantly underdiversified relative to the standard mean‐variance portfolio.

An Examination of Uncovered Interest Rate Parity in Segmented International Commodity Markets

Published: 04/18/2012   |   DOI: 10.1111/j.1540-6261.1997.tb02756.x

BURTON HOLLIFIELD, RAMAN UPPAL

We examine the effect of segmented commodity markets on the relation between forward and future spot exchange rates in a dynamic economy. We calculate the slope coefficient in our theoretical economy from regressing exchange rate changes on forward premia. With reasonable parameter values, the slope coefficient is less than unity. However, even for extreme parameters the slope is not less than zero, as found in the data. A negative slope coefficient in a nominal version of the model requires the covariance between monetary shocks and relative output shocks to be significantly negative, in contrast to the covariance in the data.

Systemic Risk and International Portfolio Choice

Published: 11/27/2005   |   DOI: 10.1111/j.1540-6261.2004.00717.x

SANJIV RANJAN DAS, RAMAN UPPAL

Returns on international equities are characterized by jumps; moreover, these jumps tend to occur at the same time across countries leading to systemic risk. We capture these stylized facts using a multivariate system of jump‐diffusion processes where the arrival of jumps is simultaneous across assets. We then determine an investor's optimal portfolio for this model of returns. Systemic risk has two effects: One, it reduces the gains from diversification and two, it penalizes investors for holding levered positions. We find that the loss resulting from diminished diversification is small, while that from holding very highly levered positions is large.

Equilibrium Portfolio Strategies in the Presence of Sentiment Risk and Excess Volatility

Published: 03/13/2009   |   DOI: 10.1111/j.1540-6261.2009.01444.x

BERNARD DUMAS, ALEXANDER KURSHEV, RAMAN UPPAL

Our objective is to identify the trading strategy that would allow an investor to take advantage of “excessive” stock price volatility and “sentiment” fluctuations. We construct a general equilibrium “difference‐of‐opinion” model of sentiment in which there are two classes of agents, one of which is overconfident about a public signal, while still optimizing intertemporally. Overconfident investors overreact to the signal and introduce an additional risk factor causing stock prices to be excessively volatile. Consequently, rational investors choose a conservative portfolio; moreover, this portfolio depends not just on the current price divergence but also on their prediction about future sentiment and the speed of price convergence.

The Exchange Rate in the Presence of Transaction Costs: Implications for Tests of Purchasing Power Parity

Published: 09/01/1995   |   DOI: 10.1111/j.1540-6261.1995.tb04060.x

PIET SERCU, RAMAN UPPAL, CYNTHIA HULLE

With transaction costs for trading goods, the nominal exchange rate moves within a band around the nominal purchasing power parity (PPP) value. We model the behavior of the band and of the exchange rate within the band. The model explains why there are below‐unity slope coefficients in regression tests of PPP, and why these increase toward unity under hyperinflation or with low‐frequency data. Our results are independent of the presence of nontraded goods in the economy.

A Multifactor Perspective on Volatility‐Managed Portfolios

Published: 10/27/2024   |   DOI: 10.1111/jofi.13395

VICTOR DeMIGUEL, ALBERTO MARTÍN‐UTRERA, RAMAN UPPAL

Moreira and Muir question the existence of a strong risk‐return trade‐off by showing that investors can improve performance by reducing exposure to risk factors when their volatility is high. However, Cederburg et al. show that these strategies fail out‐of‐sample, and Barroso and Detzel show they do not survive transaction costs. We propose a conditional multifactor portfolio that outperforms its unconditional counterpart even out‐of‐sample and net of costs. Moreover, we show that factor risk prices generally decrease with market volatility. Our results demonstrate that the breakdown of the risk‐return trade‐off is more puzzling than previously thought.