Robust Consumption and Portfolio Rules with Time-Varying Model Confidence

31 Pages Posted: 18 Jul 2012 Last revised: 6 Jun 2016

See all articles by Bong-Gyu Jang

Bong-Gyu Jang

Pohang University of Science and Technology (POSTECH)

Seungkyu Lee

Pohang University of Science and Technology (POSTECH) - Dept. of Industrial and Management Engineering

Byung Hwa Lim

The University of Suwon - Department of Economics and Finance

Date Written: July 18, 2012

Abstract

This paper investigates robust consumption and portfolio rules for an Epstein-Zin type investor who concerns about model misspecifiation. Different from Maenhout (2004), we employ a new state variable, continuation entropy, as a measure of the magnitude of the investor's ambiguity aversion toward the distribution of risky asset return. Numerical results show that the optimal consumption and portfolio rules might change dramatically according to the change in initial entropy level. We find that the optimal consumption can increase even when the investor more concerns about model misspecification and that the magnitude of the investor's elasticity of intertemporal substitution (EIS) in consumption can affect her optimal stockholdings through ambiguity aversion channel.

The appendix to this paper may be found at http://ssrn.com/abstract=2747991.

Keywords: robust portfolio, optimal consumption, optimal investment, entropy, robust control

JEL Classification: G11, G12, C61

Suggested Citation

Jang, Bong-Gyu and Lee, Seungkyu and Lim, Byung Hwa, Robust Consumption and Portfolio Rules with Time-Varying Model Confidence (July 18, 2012). Finance Research Letters, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2111949 or http://dx.doi.org/10.2139/ssrn.2111949

Bong-Gyu Jang (Contact Author)

Pohang University of Science and Technology (POSTECH) ( email )

77 Cheongam-ro
Pohang
Korea, Republic of (South Korea)

Seungkyu Lee

Pohang University of Science and Technology (POSTECH) - Dept. of Industrial and Management Engineering ( email )

Dep. Industrial and Management Engineering POSTECH
San 31 Hyoja-dong Nam-gu
Pohang, Kyung-buk 790-783
Korea
82-(0)10-2790-4237 (Phone)

Byung Hwa Lim

The University of Suwon - Department of Economics and Finance ( email )

17 Wauan-gil
Bongdam-eup
Hwaseong, Gyeonggi-do 445-743
+82-10-5007-4310 (Phone)

HOME PAGE: http://https://sites.google.com/site/byunghwalim/

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