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The impact of ambiguity on dynamic portfolio selection in the epsilon-contaminated binomial market model

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  • Petturiti, Davide
  • Vantaggi, Barbara

Abstract

We consider dynamic portfolio selection under ambiguity in the classical multi-period binomial market model. Ambiguity is incorporated in the real-world probability measure through an epsilon-contamination, that gives rise to a completely monotone capacity conveying a pessimistic investor’s ambiguous beliefs. The dynamic portfolio selection problem is formulated as a Choquet expected utility maximization problem on the final wealth. Then, the optimal final wealth is proved to be a function of the final stock price: this allows a dimension reduction of the problem, switching from an exponential to a linear size with respect to the number of periods. Finally, an explicit characterization of the optimal final wealth is given in the case of a constant relative risk aversion utility function and the interaction between the ambiguity and the relative risk aversion parameters is investigated.

Suggested Citation

  • Petturiti, Davide & Vantaggi, Barbara, 2024. "The impact of ambiguity on dynamic portfolio selection in the epsilon-contaminated binomial market model," European Journal of Operational Research, Elsevier, vol. 314(3), pages 1029-1039.
    • Handle: RePEc:eee:ejores:v:314:y:2024:i:3:p:1029-1039
    DOI: 10.1016/j.ejor.2023.11.011
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