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Portfolio Selections with Innate Learning Ability

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  • Jin-Ray Lu

    (Department of Finance, National Dong Hwa University, Taiwan)

  • Chih-Ming Chan

    (Department of Finance, National Chung Cheng University, Taiwan)

  • Wen-Shen Li

    (Department of Finance, National Dong Hwa University, Taiwan)

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    Abstract

    This study explores how innate learning ability changes portfolio selection decision-making in a continuous-time framework. We re-solve Samuelson-Merton¡¦s portfolio choice problem framed in a fixed investment opportunity set for an individual with a learning ability. In contrast to traditional theoretical results, we suggest that risk-averse investors with a risk-cognitive ability hold a lower fraction of risky stocks to hedge against the jump risk and volatility risk since the investors are cognizant of the market risks. In addition, an individual whose learning process correlates strongly with stock movements would be likely to invest more in stocks.

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    Bibliographic Info

    Article provided by College of Business, and College of Finance, Feng Chia University, Taichung, Taiwan in its journal International Journal of Business and Economics.

    Volume (Year): 10 (2011)
    Issue (Month): 3 (December)
    Pages: 201-217

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    Handle: RePEc:ijb:journl:v:10:y:2011:i:3:p:201-217

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    Related research

    Keywords: learning; asset allocation; cognition;

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    References

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    1. Michael W. Brandt & Amit Goyal & Pedro Santa-Clara & Jonathan R. Stroud, 2005. "A Simulation Approach to Dynamic Portfolio Choice with an Application to Learning About Return Predictability," Review of Financial Studies, Society for Financial Studies, vol. 18(3), pages 831-873.
    2. Detemple, Jerome B, 1986. " Asset Pricing in a Production Economy with Incomplete Information," Journal of Finance, American Finance Association, vol. 41(2), pages 383-91, June.
    3. Chellathurai, Thamayanthi & Draviam, Thangaraj, 2007. "Dynamic portfolio selection with fixed and/or proportional transaction costs using non-singular stochastic optimal control theory," Journal of Economic Dynamics and Control, Elsevier, vol. 31(7), pages 2168-2195, July.
    4. Guidolin, Massimo & Timmermann, Allan, 2007. "Asset allocation under multivariate regime switching," Journal of Economic Dynamics and Control, Elsevier, vol. 31(11), pages 3503-3544, November.
    5. T. Borgers & R. Sarin, 2010. "Learning Through Reinforcement and Replicator Dynamics," Levine's Working Paper Archive 380, David K. Levine.
    6. R. C. Merton, 1970. "Optimum Consumption and Portfolio Rules in a Continuous-time Model," Working papers 58, Massachusetts Institute of Technology (MIT), Department of Economics.
    7. Michael J. Brennan & Yihong Xia, 2002. "Dynamic Asset Allocation under Inflation," Journal of Finance, American Finance Association, vol. 57(3), pages 1201-1238, 06.
    8. Jun Liu & Francis A. Longstaff & Jun Pan, 2002. "Dynamic Asset Allocation With Event Risk," NBER Working Papers 9103, National Bureau of Economic Research, Inc.
    9. Yihong Xia, 2001. "Learning about Predictability: The Effects of Parameter Uncertainty on Dynamic Asset Allocation," Journal of Finance, American Finance Association, vol. 56(1), pages 205-246, 02.
    10. Borgers, Tilman, 1996. "On the Relevance of Learning and Evolution to Economic Theory," Economic Journal, Royal Economic Society, vol. 106(438), pages 1374-85, September.
    11. Bertille Antoine, 2010. "Portfolio Selection with Estimation Risk: A Test-Based Approach," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 10(1), pages 164-197, 2012 10 1.
    12. repec:oup:jfinec:v:10:y:2012:i:1:p:164-197 is not listed on IDEAS
    13. Merton, Robert C., 1980. "On estimating the expected return on the market : An exploratory investigation," Journal of Financial Economics, Elsevier, vol. 8(4), pages 323-361, December.
    14. Sushil Bikhchandani & David Hirshleifer & Ivo Welch, 1998. "Learning from the Behavior of Others: Conformity, Fads, and Informational Cascades," Journal of Economic Perspectives, American Economic Association, vol. 12(3), pages 151-170, Summer.
    15. Samuelson, Paul A, 1969. "Lifetime Portfolio Selection by Dynamic Stochastic Programming," The Review of Economics and Statistics, MIT Press, vol. 51(3), pages 239-46, August.
    16. Jakša Cvitanić & Ali Lazrak & Lionel Martellini & Fernando Zapatero, 2006. "Dynamic Portfolio Choice with Parameter Uncertainty and the Economic Value of Analysts' Recommendations," Review of Financial Studies, Society for Financial Studies, vol. 19(4), pages 1113-1156.
    17. Thorsten Hens & Peter Wöhrmann, 2007. "Strategic asset allocation and market timing: a reinforcement learning approach," Computational Economics, Society for Computational Economics, vol. 29(3), pages 369-381, May.
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