Inflation, Risk Preference And Financial Asset Allocation

The problem of financial asset allocation under uncertainty has always been an important part for academia and financial institutions, and the final purpose for this research is to maximize the utility function of investors. From macro perspective to study the uncertainty risk is the main method for modern asset allocation theory. Generally, the statistic indices for analyzing the economic fluctuation in the macroeconomics are economic growth rate, consumption rate, inflation rate, unemployment rate and investment rate which are important for research the financial market. The Consumption Capital Asset Pricing Model(CCAPM) takes the microfinance into the economic research framework which describes the relationship between financial market and macro economy, and makes up the deficiency of Capital Asset Pricing Model(CAPM). Also, CCAPM establishes the foundation for the research of micro financial asset allocation and macroeconomic risk.Inflation rate is an important statistic index for studying the macroeconomic fluctuation which is also the main risk for investors in asset allocation. Under this uncertain conditions, the consumption behavior, saving behavior and investing behavior for rational people will be change. Theoretically, inflation has both the redistribution effect and wealth effect which may have different effects for various groups. From the investing perspective, long-term investors are more concerned about the inflation risk so that they will use different assets to hedge against the inflation and get the optimal investment strategies. In the paper, we will get the optimal allocation of inflation, risk preference, investment period and financial asset for investors under different utility functions(CRRA and HARA) which is the first main part of the article.Rational investors will change the asset allocation proportion under uncertainty in order to maximize the utility function. Cash, stock and bond will be the main investment products for asset allocation in classical literature, and investors will adjust the proportion to reduce the risk of economic fluctuation. In fact, this behavior may not hedge against the risk which can only reduce the loss of assets caused by uncertainty. Therefore, it is necessary to introduce a kind derivative product which has the function of hedging. In this paper, an inflation index bond that has the hedging effect and the investor consumption will be taken into the asset allocation model. Finally, we will construct a portfolio to hedge against inflation risk and get the optimal portfolio strategy in general equilibrium which is the second main part of the paper.Investors will always maintain the previous consumption level in asset allocation in order not to change the total utility much. Therefore, it is necessary to study the consumption habit formation of investors. In general equilibrium, asset price is completely determined by beta coefficient of consumption. However, this hypothesis is facing challenges from the empirical analysis, and "the equity premium puzzle" is just based on this paradox. Introducing consumption habit formation into the utility function is the main method to solve the "the equity premium puzzle" problem. Therefore, it has important theoretical and practical significance to consider the consumption habit formation in asset allocation model. However, consumption habit formation will be changed under inflation. In this condition, investor will have money illusion, so it is necessary to make a distinction of the consumption habit formation. In the paper, consumption habit formation will be divided into normal consumption habit formation and real consumption habit formation, and we will study the effect of consumption habit formation on asset allocation with or without the inflation condition. Also, we will derive the optimal consumption of investors which is the third main part of the paper.In the paper, we will study the financial asset allocation under inflation based on the three above views. The final purpose is to maximize the utility function of investors, namely preserving and increasing the value of asset. At last, we will derive the optimal portfolio strategies. The conclusions of this paper are as follows: First, the factors that can affect asset allocation are investment period, inflation, risk preference. However, these three factors above have different effects on asset allocation in the framework of CRRA and HARA. Especially, long sale will appear in the HARA framework. Second, the portfolio strategies will be divided into two parts: hedge portfolio and speculatve portfolio. However, only the hedge portfolio will be changed when introducing the inflation index bond into the model. Third, the weight of zero coupon bond and inflation index bond in the nominal habit formation will be larger than that in the real habit formation under the same consumption habit level. Also, with the increasement of inflation, the weight of risk asset in the nominal habit formation will be increased.