Robust Portfolio Choice with Uncertainty About Jump and Diffusion Risk
43 Pages Posted: 11 Jan 2012 Last revised: 25 Apr 2012
Date Written: April 25, 2012
We analyze the portfolio planning problem of an ambiguity averse investor. The stock follows a jump-diffusion process, and there is ambiguity about the drift of the stock and the intensity of jumps. The consequences of ambiguity with respect to jump and diffusion risk are by no means the same. In an incomplete market, it is mainly ambiguity about one of the two risk factors which drives the optimal stock weight, and the utility loss is largest if this ambiguity is ignored. Furthermore, we show that the loss from market incompleteness is decreasing in the level of ambiguity.
Keywords: ambiguity, jump-diffusion model, robust control, utility loss, market completeness
JEL Classification: G11
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