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Corrections Should Trigger Rebalancing

William W. Jennings and Brian C. Payne
The Journal of Wealth Management Winter 2020, 23 (3) 37-49; DOI: https://doi.org/10.3905/jwm.2020.1.116
William W. Jennings
is a professor of finance and investments at the US Air Force Academy in Colorado Springs, CO
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Brian C. Payne
is an assistant professor of finance at the University of Nebraska in Omaha, NE
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Abstract

We start from the provocative contention that if an investor did not rebalance earlier this year (2020), then that investor does not have an asset allocation policy. More specifically, that investor does not have a rebalancing policy to preserve their asset allocation. We then work backward from a presumption that a correction needs to induce a rebalancing trade and develop an algebraic solution for the width of the rebalancing range to ensure it does so. Across a range of reasonable assumptions, rebalancing ranges need to be tighter than traditional norms.

TOPICS: Statistical methods, portfolio construction, risk management

Key Findings

  • • Wealth managers promising benefits from rebalancing need to deliver on that promise.

  • • Corrections and bear markets, surprisingly, do not trigger traditional rebalancing ranges.

  • • We develop a nontrivial analytical expression for rebalancing ranges that will trigger in a stock market correction and find they encourage much tighter rebalancing ranges.

  • © 2020 Pageant Media Ltd
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The Journal of Wealth Management: 23 (3)
The Journal of Wealth Management
Vol. 23, Issue 3
Winter 2020
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Corrections Should Trigger Rebalancing
William W. Jennings, Brian C. Payne
The Journal of Wealth Management Oct 2020, 23 (3) 37-49; DOI: 10.3905/jwm.2020.1.116

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Corrections Should Trigger Rebalancing
William W. Jennings, Brian C. Payne
The Journal of Wealth Management Oct 2020, 23 (3) 37-49; DOI: 10.3905/jwm.2020.1.116
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  • Article
    • Abstract
    • NORMS IN THE REBALANCING LITERATURE
    • THE ALGEBRA OF REBALANCING
    • NUMERICAL EXAMPLES
    • WHAT IF A PORTFOLIO DRIFTED PRIOR TO THE CORRECTION?
    • AN ALGEBRAIC APPROACH TO PRECORRECTION DRIFT
    • ROBUSTNESS TO BOND MARKET MOVES
    • DISCUSSION AND CONCLUSION
    • ACKNOWLEDGMENTS
    • ADDITIONAL READING
    • ENDNOTES
    • REFERENCES
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