A Premium for Parameter Uncertainty in Equities
15 Pages Posted: 29 Jun 2014 Last revised: 3 Aug 2014
Date Written: August 3, 2014
The literature on the effects of parameter uncertainty on optimal portfolio choice suggests the existence of a premium for parameter uncertainty in asset returns. We use a simple extension to classical mean-variance portfolio optimization and devise a robust strategy to benefit from such a premium. Using well-known, long time series of equity returns, we show that this strategy indeed outperforms competitor strategies and yields positive and significant alphas relative to the most prominent factor models. We interpret these results to provide empirical support for the existence of a parameter uncertainty premium in equity returns.
Keywords: parameter uncertainty, portfolio choice
JEL Classification: G11
Suggested Citation: Suggested Citation