Model Uncertainty for Long-Term Investors

55 Pages Posted: 18 Mar 2011 Last revised: 19 Sep 2014

See all articles by Bart F. Diris

Bart F. Diris

Erasmus University Rotterdam (EUR) - Department of Econometrics; Netspar

Date Written: September 18, 2014

Abstract

We develop a method to identify the most important predictors of long-term asset returns and use it to analyze the impact of model uncertainty on long-term investors. We find that the impact of model uncertainty changes a lot over time which leads to considerable time-variation in all moments of the predictive stock return distribution. Even though stocks are safer in the long-run than short-run when model uncertainty is low, stocks are actually riskier in the long-run when model uncertainty is high. For buy-and-hold and dynamic portfolios with long investment horizons, incorporating model uncertainty substantially lowers the equity allocation.

Keywords: Model uncertainty, strategic asset allocation, term-structure of risk

JEL Classification: C11, C32, G11

Suggested Citation

Diris, Bart Franciscus and Diris, Bart Franciscus, Model Uncertainty for Long-Term Investors (September 18, 2014). Available at SSRN: https://ssrn.com/abstract=1786587 or http://dx.doi.org/10.2139/ssrn.1786587

Bart Franciscus Diris (Contact Author)

Netspar ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Erasmus University Rotterdam (EUR) - Department of Econometrics ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands

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