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Dynamic Asset Allocation with Ambiguous Return Predictability, working paper
, 2009
"... We study an investor’s optimal consumption and portfolio choice problem when he confronts with two possibly misspecified submodels of stock returns: one with IID returns and the other with predictability. We adopt a generalized recursive ambiguity model to accommodate the investor’s aversion to mode ..."
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Cited by 22 (3 self)
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We study an investor’s optimal consumption and portfolio choice problem when he confronts with two possibly misspecified submodels of stock returns: one with IID returns and the other with predictability. We adopt a generalized recursive ambiguity model to accommodate the investor’s aversion to model uncertainty. The investor deals with specification doubts by slanting his beliefs about submodels of returns pessimistically, causing his investment strategy to be more conservative than the Bayesian strategy. This effect is large for high and low values of the predictive variable. Unlike in the Bayesian framework, the hedging demand against model uncertainty may cause the investor’s stock allocations to first decrease sharply and then increase with his prior probability of the IID model, even when the expected stock return under the IID model is lower than under the predictability model. Adopting suboptimal investment strategies by ignoring model uncertainty can lead to sizable welfare costs.
Information Inertia
, 2012
"... Note: The Discussion Papers in this series are prepared by members of the Department of Economics, University of Essex, for private circulation to interested readers. They often represent preliminary reports on work in progress and should therefore be neither quoted nor referred to in published work ..."
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Cited by 1 (0 self)
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Note: The Discussion Papers in this series are prepared by members of the Department of Economics, University of Essex, for private circulation to interested readers. They often represent preliminary reports on work in progress and should therefore be neither quoted nor referred to in published work without the written consent of the author. Information Inertia ∗
ESSAYS ON ASSET PRICING AND PORTFOLIO CHOICE
"... The first chapter “Rare Disasters and the Term Structure of Interest Rates ” offers an explanation for the properties of the nominal term structure of interest rates and time-varying bond risk premia based on a model with rare consumption disaster risk. In the model, expected inflation follows a mea ..."
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The first chapter “Rare Disasters and the Term Structure of Interest Rates ” offers an explanation for the properties of the nominal term structure of interest rates and time-varying bond risk premia based on a model with rare consumption disaster risk. In the model, expected inflation follows a mean reverting process but is also subject to possible large (positive) shocks when consumption disasters occur. The possibility of jumps in inflation increases nominal yields and the yield spread, while time-variation in the inflation jump probability drives time-varying bond risk premia. Predictability regressions offer independent evidence for the model’s ability to generate realistic implications for both the stock and bond markets. The second chapter “Rare booms and disasters in a multi-sector endowment economy” studies the cross-section of stock returns. Why do value stocks have higher expected returns than growth stocks, in spite of having lower risk? Why do these stocks exhibit positive abnormal performance while growth stocks exhibit negative abnormal performance? This paper offers a rare-events based explanation, that can also account for facts about the aggregate market. Patterns in time-series predictability offer independent evidence for the