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Robust consumption and portfolio rules with time-varying model confidence

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  • Jang, Bong-Gyu
  • Lee, Seungkyu
  • Lim, Byung Hwa

Abstract

This paper investigates robust optimal consumption and portfolio rules for an Epstein-Zin type investor who is concerned about model misspecification. We propose a semi-explicit solution for the generalized problem of [Hansen, L., Sargent, T., 2001. Robust control and model uncertainty. The American Economic Review 91 (2), 60–66.]. Numerical results show that the optimal behaviors change dramatically according to the investor’s confidence level on the estimated model and that the elasticity of intertemporal substitution in consumption can affect investment ratio. In addition, we show how the investor decides her optimal behaviors for the worst-case scenario.

Suggested Citation

  • Jang, Bong-Gyu & Lee, Seungkyu & Lim, Byung Hwa, 2016. "Robust consumption and portfolio rules with time-varying model confidence," Finance Research Letters, Elsevier, vol. 18(C), pages 342-352.
    • Handle: RePEc:eee:finlet:v:18:y:2016:i:c:p:342-352
    DOI: 10.1016/j.frl.2016.05.012
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