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Asset pricing model uncertainty and portfolio choice

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  • Carrasco, Ignacio
  • Hansen, Erwin

Abstract

We study how asset pricing uncertainty affects the performance of a Bayesian mean-variance investor's portfolio allocation decisions. The investor allocates their wealth between a set of benchmark portfolios associated with a particular asset pricing model and a set of additional test assets. He centers their priors on model mispricing (alpha) around zero, but the true extent of mispricing is uncertain. When using recently introduced factor asset pricing models (Fama and French, 2015; and Hou et al., 2015), we find that allowing for mispricing uncertainty increases the point estimates of portfolio performance in most cases. However, their statistical significance is weaker.

Suggested Citation

  • Carrasco, Ignacio & Hansen, Erwin, 2022. "Asset pricing model uncertainty and portfolio choice," Finance Research Letters, Elsevier, vol. 45(C).
    • Handle: RePEc:eee:finlet:v:45:y:2022:i:c:s1544612321002257
    DOI: 10.1016/j.frl.2021.102144
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    References listed on IDEAS

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    1. Carhart, Mark M, 1997. "On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, vol. 52(1), pages 57-82, March.
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    6. Fama, Eugene F. & French, Kenneth R., 2015. "A five-factor asset pricing model," Journal of Financial Economics, Elsevier, vol. 116(1), pages 1-22.
    7. Kewei Hou & Chen Xue & Lu Zhang, 2020. "Replicating Anomalies," Review of Financial Studies, Society for Financial Studies, vol. 33(5), pages 2019-2133.
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    Cited by:

    1. Hansen, Erwin, 2022. "Economic evaluation of asset pricing models under predictability," Journal of Empirical Finance, Elsevier, vol. 68(C), pages 50-66.

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    More about this item

    Keywords

    Model uncertainty; Factor models; Bayesian investor; Portfolio performance;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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