02565cam a22002537 4500001000600000003000500006005001700011008004100028100002000069245015300089260006600242490004100308500001800349520145100367530006101818538007201879538003601951690011201987700002102099710004202120830007602162856003702238856003602275w7377NBER20150131090359.0150131s1999 mau||||fs|||| 000 0 eng d1 aChacko, George.10aDynamic Consumption and Portfolio Choice with Stochastic Volatility in Incomplete Marketsh[electronic resource] /cGeorge Chacko, Luis M. Viceira. aCambridge, Mass.bNational Bureau of Economic Researchc1999.1 aNBER working paper seriesvno. w7377 aOctober 1999.3 aThis paper analyzes optimal portfolio choice and consumption with stochastic volatility in incomplete markets. Using the Duffie-Epstein (1992) formulation of recursive utility in continuous time, it shows that the optimal portfolio demand for stocks under stochastic volatility varies strongly with the investor's coefficient of relative risk aversion, but only slightly with her elasticity of intertemporal substitution; by contrast, optimal consumption relative to wealth depends on both preference parameters. This paper also shows that stochastic variation in volatility produces an optimal intertemporal hedging demand for stocks which is negative when changes in volatility are instantaneously negatively correlated with excess stock returns and investors have coefficients of relative risk aversion larger than one. The absolute size of this demand increases with the size of this correlation, and also with the persistence of shocks to volatility. An application to the US stock market shows that empirically this correlation is negative and large, which implies a negative hedging demand for stocks. This application also shows that only low frequency shocks to volatility exhibit enough persistence to generate sizable hedging demands by long-term, risk averse investors. A comparative statics exercise shows that the size of hedging demands is considerably more sensitive to changes in persistence than to changes in correlation. aHardcopy version available to institutional subscribers. aSystem requirements: Adobe [Acrobat] Reader required for PDF files. aMode of access: World Wide Web. 7aG12 - Asset Pricing • Trading Volume • Bond Interest Rates2Journal of Economic Literature class.1 aViceira, Luis M.2 aNational Bureau of Economic Research. 0aWorking Paper Series (National Bureau of Economic Research)vno. w7377.4 uhttp://www.nber.org/papers/w737741uhttp://dx.doi.org/10.3386/w7377