The asset allocation puzzle is still a puzzle

Intertemporal hedging activity has been advocated as being the solution to the asset allocation puzzle. A standing assumption made in the dynamic asset allocation literature is that one or several bonds can perfectly hedge the interest rate risk and related market price of risk in the Economy. In a multi asset world, ceteris paribus, such an assumption biases the portfolio allocation of a non-myopic investor towards bonds. We extend the literature to allow for an incomplete bond market. When solving for the optimal portfolio choice of a rational investor, it is shown that investors with a high level of risk aversion could invest more in stocks than in bonds.