April 27, 2023 Personal Wealth Rational Reminder EP 250: Prof. John Y. Campbell: Financial Decisions for Long-term Investors John Y. Campbell is the Morton L. and Carole S. Olshan Professor of Economics at Harvard University. He has published over 100 articles and books on finance, including The Econometrics of Financial Markets (with Andrew Lo and Craig MacKinlay, 1997), Strategic Asset Allocation: Portfolio Choice for Long-Term Investors (with Luis Viceira, 2002), The Squam Lake Report: Fixing the Financial System (with the Squam Lake Group, 2010), and Financial Decisions and Markets: A Course in Asset Pricing (2018). Campbell has served as President of the American Finance Association, as Chair of the Harvard Economics Department, and as a board member of the Harvard Management Company, and he is a founding partner of the asset management firm Arrowstreet Capital. Navigating the world of finance and investing is undeniably complicated, sometimesunnecessarily so. And all too often the people who end up making the most costly financialmistakes are those who can least afford to do so. But what exactly needs to change in order formore people to make wise and well-informed financial decisions? And how do we go aboutimplementing those changes? Joining us today to help us unpack this topic and the manydecisions involved in the world of investing is John Y. Campbell, a British-American economist,professor of economics at Harvard, and founding partner at Arrow Street Capital, a systematicasset management firm based in Boston. John has published hundreds of articles on a range oftopics including fixed income, equality valuation, portfolio choices, and household finance, all ofwhich we explore in today’s expansive conversation. We kick things off by discussing utilitytheory, why it’s so important to the study of finance, and what it can teach us about riskaversion, before delving into portfolio structure, asset allocation, and hedging. John alsoexpands on the study of household finance, the mistakes that households typically make, whyhousehold behaviour tends to differ from theoretical predictions, and how to bring theory andbehaviour into alignment. We wrap things up by discussing how financial literacy, education, andregulation can improve outcomes for households before hearing John’s advice on selecting anoptimal mortgage contract along with an overview of the type of risk that mortgage contractsexpose you to. Today’s episode is jam-packed with information and insights from a profoundlyknowledgeable figure in academia. Be sure to stay tuned until the end to hear John’s beautifulanswer to the question: “What is your definition of success?”. Key Points From This Episode: An overview of asset pricing theory; unpacking the utility function in finance, what it teaches us about being risk averse, and how it is used to determine the value we place on any amount of money. (0:04:01) The implications of using the Capital Asset Pricing Model (CAPM) for portfolio choice.(0:13:58) The difference between arbitrage pricing theory and the Intertemporal Capital Asset PricingModel (ICAPM). (0:18:15) How predictability in stock returns affects portfolio advice for long-term investors and whyJohn prefers the cyclically adjusted price-to-earnings (CAPE) ratio. (0:23:40) Why a long-term inflation index bond is the ideal risk-free asset for a long-term investor, andhow portfolio advice, concerning bonds, changes when inflation index bonds are notavailable. (0:28:32) The impact that labour income should have on optimal portfolio choice and the relationshipbetween human capital and financial assets as you age. (0:35:31) © 2023 Rational Reminder Podcast 1 RRP 250 Show Notes Learn about John’s 2003 paper entitled ‘Bad Beta, Good Beta’ and how intertemporal assetpricing explains differences in returns between value and growth stocks. (0:38:33) The benefits and drawbacks of value investing: why historically they do well on average, butextremely poorly over certain periods. (0:41:12) A breakdown of stochastic volatility and how it affects portfolio choice for long-term investors.(0:47:16) How long-term equity investors should approach foreign currency hedging in their portfolios,and how fixed-income investors should deal with foreign currency exposure. (0:50:07) The study of household finance, what it aims to answer, and the major challenges in this areaof study. (0:53:54) An overview of the mistakes that households typically make, how costly they can be, and whyhousehold behaviour tends to differ from theoretical predictions. (0:59:57) Suggestions on how household behaviour and theoretical predictions can be brought intoalignment and the methods that have the most potential to improve outcomes for households.(01:04:47) What households should take into account when selecting an optimal mortgage contract andthe different types of risk that mortgage contracts expose people to.[01:10:18] How John’s definition of success has shifted over the years, the joy of academia, and why heis especially grateful for the opportunity to connect with students on their educational journey.(01:16:04) Participate in our Community Discussion about this Episode: https://community.rationalreminder.ca/t/episode-250-prof-john-y-campbell-financial-decisions-for-long-term-investors-discussion-thread/23202 Links From Today’s Episode: Rational Reminder on iTunes — https://itunes.apple.com/ca/podcast/the-rational-reminder-podcast/id1426530582.Rational Reminder Website — https://rationalreminder.ca/ Shop Merch — https://shop.rationalreminder.ca/ Join the Community — https://community.rationalreminder.ca/ Follow us on Twitter — https://twitter.com/RationalRemind Follow us on Instagram — @rationalreminder Benjamin on Twitter — https://twitter.com/benjaminwfelix Cameron on Twitter — https://twitter.com/CameronPassmore John Y. Campbell — https://scholar.harvard.edu/campbell/home ‘Who Should Buy Long-Term Bonds’ — https://www.nber.org/system/files/working_papers/w6801/w6801.pdf ‘Inflation Bets or Deflation Hedges? The Changing Risks of Nominal Bonds’ — https://scholar.harvard.edu/files/campbell/files/campbellsunderamviceira_20160523.pdf ‘Growth or Glamour? Fundamentals and Systematic Risk in Stock Returns’ — https://scholar.harvard.edu/sites/scholar.harvard.edu/files/campbell/files/gorg20090319_copyedited.pdf ‘Bad Beta, Good Beta’ — https://scholar.harvard.edu/sites/scholar.harvard.edu/files/campbell/files/bbgb_2004_nberw9509.pdf ‘An Intertemporal CAPM with Stochastic Volatility’ — https://scholar.harvard.edu/sites/scholar.harvard.edu/files/campbell/files/cgpt_volatilityrisk20170123final.pdf ‘Global Currency Hedging’ — https://scholar.harvard.edu/sites/scholar.harvard.edu/files/campbell/files/globalcurrencyhedging_20090128_manuscript.pdf ‘Biases in long-horizon predictive regressions’ — https://www.sciencedirect.com/science/article/abs/pii/S0304405X21004013 ‘What Drives Booms and Busts in Value?’ — https://scholar.harvard.edu/sites/scholar.harvard.edu/files/campbell/files/cgp_valueboomsbusts_20230311.pdf ‘Household Finance’ — https://scholar.harvard.edu/sites/scholar.harvard.edu/files/campbell/files/householdfinance_jof_2006.pdf ‘The Cross-Section of Household Preferences’ — https://scholar.harvard.edu/sites/scholar.harvard.edu/files/campbell/files/calvetcampbellgomessodini_20221027.pdf ‘Restoring Rational Choice: The Challenge of Consumer Financial Regulation’ — https://scholar.harvard.edu/sites/scholar.harvard.edu/files/campbell/files/elylecture_march2016.pdf ‘Down or Out: Assessing the Welfare Costs of Household Investment Mistakes’ — https://www.journals.uchicago.edu/doi/abs/10.1086/524204 ‘A Model of Mortgage Default’ — https://scholar.harvard.edu/sites/scholar.harvard.edu/files/campbell/files/mortdefault13022014.pdf ‘Household Risk Management and Optimal Mortgage Choice’ — https://scholar.harvard.edu/campbell/publications/household-risk-management-and-optimal-mortgage-choice ‘Predicting the Equity Premium Out of Sample: Can Anything Beat the Historical Average?’ — https://www.nber.org/papers/w11468 ‘An Asset Allocation Puzzle’ — https://www.nber.org/papers/w4857 Share: Facebook Twitter LinkedIn Email IIROC AdvisorReport
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