Template-Type: ReDIF-Paper 1.0
Author-Name: Hui Chen  
Author-X-Name-First: Hui
Author-X-Name-Last: Chen
Author-Email: huichen@mit.edu
Author-Workplace-Name: MIT Sloan School of Management
Author-Name: Nengjiu Ju
Author-X-Name-First: Nengjiu
Author-X-Name-Last: Ju
Author-Email: nengjiu@ust.hk
Author-Workplace-Name: Department of Finance, the Hong Kong University of Science and Technology
Author-Name: Jianjun Miao
Author-X-Name-First: Jianjun
Author-X-Name-Last: Miao
Author-Email: miaoj@bu.edu
Author-Workplace-Name: Department of Economics, Boston University
Title: Dynamic Asset Allocation with Ambiguous Return Predictability
Abstract: We study an investor's optimal consumption and portfolio choice problem when he confronts with two possibly misspecified submodels of stock returns: one with IID returns and the other with predictability. We adopt a generalized recursive ambiguity model to accommodate the investor's aversion to model uncertainty. The investor deals with specification doubts by slanting his beliefs about submodels of returns pessimistically, causing his investment strategy to be more conservative than the Bayesian strategy. This effect is large for extreme values of the predictive variable. Unlike in the Bayesian framework, model uncertainty induces a hedging demand,
which may cause the investor to decrease his stock allocations sharply and then increase with his prior probability of IID returns. Adopting suboptimal investment strategies by ignoring model uncertainty can lead to sizable welfare costs.
Length: 44
Creation-Date: 2008-09
Revision-Date: 2009-02
Publication-Status: 
File-URL:http://www.bu.edu/econ/ied/dp/papers/dp179.pdf
File-Format: Application/pdf
File-Function: 
Number: dp-179
Classification-JEL: D81, D83, G11, E21
Keywords: generalized recursive ambiguity utility, ambiguity aversion, model uncertainty, learning, portfolio choice, robustness, return predictability
Handle: RePEc:bos:iedwpr:dp-179