Robust Portfolio Choice with Ambiguity and Learning About Return Predictability
47 Pages Posted: 9 Jun 2011 Last revised: 26 Apr 2012
Date Written: April 26, 2012
We analyze the optimal stock-bond portfolio under both learning and ambiguity aversion. Stock returns are predictable by an observable and an unobservable predictor, and the investor has to learn about the latter. Furthermore, the investor is ambiguity-averse and has a preference for investment strategies that are robust to model misspecifications. We derive a closed-form solution for the optimal robust investment strategy. We find that both learning and ambiguity aversion impact the level and structure of the optimal stock investment. Suboptimal strategies resulting either from not learning or from not considering ambiguity can lead to economically significant losses.
Keywords: return predictability, portfolio choice, ambiguity, learning, robust control
JEL Classification: G11
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