An ICAPM Framework for Asset Allocation

Abstract

Asset allocation should rely on a sound theoretical foundation that is empirically valid and robust in practice. Intertemporal CAPM (ICAPM) portfolio theory resembles the hedging/return-seeking portfolios approach sometimes used in practice, but with a sound theoretical foundation, empirical support, and attractive features for functional implementation. ICAPM portfolio theory largely resolves key issues with modern portfolio theory and standard CAPM portfolio theory, while providing a unified framework for liability-relative, goals-based, and asset-only asset allocation. The author documents the application of ICAPM portfolio theory to practice, addressing key implementation and technical issues related to the liability hedge, risky-asset portfolio optimization and constraints, portfolio selection and Monte Carlo simulation, and extensions to goals-based and asset-only asset allocation.