Parameter Uncertainty in Asset Allocation

46 Pages Posted: 18 Dec 2009 Last revised: 18 Mar 2010

Campbell R. Harvey

Duke University - Fuqua School of Business; National Bureau of Economic Research (NBER); Duke Innovation & Entrepreneurship Initiative

John Liechty

Pennsylvania State University, University Park

Merrill W. Liechty

Drexel University - Department of Decision Sciences

Date Written: December 17, 2009

Abstract

We revisit an investment experiment that compares the performance of an investor using Bayesian methods for determining portfolio weights with an investor that uses the Monte Carlo based resampling approach advocated in Michaud (1998). Markowitz and Usmen (2003) showed that the Michaud investor always won. However, in the original experiment, the Bayes investor was handicapped because the algorithm that was used to evaluate the predictive distribution of the portfolio provided only a rough approximation. We level the playing field by allowing the Bayes investor to use a more standard algorithm. Our results sharply contrast with those of the original experiment. The final part of our paper proposes a new investment experiment that is much more relevant for the average investor - a one-period ahead asset allocation. We examine in detail why this is the best comparison to make, and why the Bayes investor always wins.

Keywords: Bayesian decision problem, parameter uncertainty, optimal portfolios, utility function maximization, resampling

Suggested Citation

Harvey, Campbell R. and Liechty, John and Liechty, Merrill W., Parameter Uncertainty in Asset Allocation (December 17, 2009). Available at SSRN: https://ssrn.com/abstract=1525121 or http://dx.doi.org/10.2139/ssrn.1525121

Campbell R. Harvey

Duke University - Fuqua School of Business ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-7768 (Phone)
919-660-8030 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Duke Innovation & Entrepreneurship Initiative ( email )

215 Morris St., Suite 300
Durham, NC 27701
United States

John Liechty

Pennsylvania State University, University Park ( email )

University Park
State College, PA 16802
United States

Merrill W. Liechty (Contact Author)

Drexel University - Department of Decision Sciences ( email )

3141 Chestnut St
Philadelphia, PA 19104
United States
215-895-2459 (Phone)
215-895-2907 (Fax)

HOME PAGE: http://www.pages.drexel.edu/~mwl25/

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