Keep it Simple: Dynamic Bond Portfolios Under Parameter Uncertainty

44 Pages Posted: 12 Mar 2012 Last revised: 16 Nov 2012

See all articles by Peter Feldhütter

Peter Feldhütter

Copenhagen Business School

Linda Sandris Larsen

Copenhagen Business School

Claus Munk

Copenhagen Business School

Anders B. Trolle

Copenhagen Business School - Department of Finance

Date Written: March 5, 2012

Abstract

We empirically investigate the importance of parameter uncertainty to bond investors. Using a Bayesian approach, we quantify the expected utility loss due to parameter uncertainty from following seemingly optimal dynamic portfolio strategies. Expected utility losses are increasing in the number of term structure factors and the complexity of the risk premium specification. Even with long data sets to estimate parameters, an investor with typical risk aversion is better off following a portfolio strategy implied by a misspecified but parsimonious model than a correctly-specified but difficult-to-estimate three-factor affine model with time-varying risk premia.

Keywords: Suboptimal investments, parameter uncertainty, utility losses, bond portfolios, MCMC estimation

JEL Classification: G11, G12, C13

Suggested Citation

Feldhütter, Peter and Larsen, Linda Sandris and Munk, Claus and Trolle, Anders B., Keep it Simple: Dynamic Bond Portfolios Under Parameter Uncertainty (March 5, 2012). Available at SSRN: https://ssrn.com/abstract=2018844 or http://dx.doi.org/10.2139/ssrn.2018844

Peter Feldhütter

Copenhagen Business School ( email )

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark

Linda Sandris Larsen

Copenhagen Business School ( email )

Solbjerg Plads 3, A5
Frederiksberg, 2000
Denmark

Claus Munk (Contact Author)

Copenhagen Business School ( email )

Department of Finance
Solbjerg Plads 3
Frederiksberg, DK-2000
Denmark

HOME PAGE: http://sites.google.com/view/clausmunk/home

Anders B. Trolle

Copenhagen Business School - Department of Finance ( email )

Solbjerg Plads 3
Frederiksberg, DK-2000
Denmark

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