Robust Consumption and Portfolio Rules with Time-Varying Model Confidence
31 Pages Posted: 18 Jul 2012 Last revised: 6 Jun 2016
Date Written: July 18, 2012
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: Suggested Citation