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The relaxed investor and parameter uncertainty

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Author Info
L.C.G. Rogers () (University of Bath, Department of Mathematical Sciences, Bath BA2 7AY, UK Manuscript)

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Abstract

We firstly consider an investor faced with the classical Merton problem of optimal investment in a log-Brownian asset and a fixed-interest bond, but constrained only to change portfolio (and, if relevant, consumption) choices at times which are a multiple of h. We show that the cost of this constraint can be well described by a power series expansion in h, the first few terms of which we determine explicitly. Typically, this cost is not too large. We then compare this with the cost of parameter uncertainty, as modelled by supposing that the rate of return on the share has a prior Gaussian distribution. We find that the effect of parameter uncertainty is typically bigger than the effects of infrequent policy review.

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Publisher Info
Article provided by Springer in its journal Finance and Stochastics.

Volume (Year): 5 (2001)
Issue (Month): 2 ()
Pages: 131-154
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Handle: RePEc:spr:finsto:v:5:y:2001:i:2:p:131-154

Note: received: November 1999; final version received: June 2000
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Related research
Keywords: Merton consumption problem; Merton investment problem; time lag; parameter uncertainty;

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Find related papers by JEL classification:
C61 - Mathematical and Quantitative Methods - - Mathematical Methods and Programming - - - Optimization Techniques; Programming Models; Dynamic Analysis
D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
D90 - Microeconomics - - Intertemporal Choice and Growth - - - General
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Xavier Gabaix & David Laibson & Guillermo Moloche & Stephen Weinberg, 2005. "Information Acquisition: Experimental Analysis of a Boundedly Rational Model," Levine's Bibliography 666156000000000480, UCLA Department of Economics. [Downloadable!]
  2. Yiannis Kamarianakis & Anastasios Xepapadeas, 2006. "Controlling the risky fraction process with an ergodic criterion," Working Papers 0710, University of Crete, Department of Economics. [Downloadable!]
  3. Hardy Hulley & T. A. McWalter, 2008. "Quadratic Hedging of Basis Risk," Research Paper Series 225, Quantitative Finance Research Centre, University of Technology, Sydney. [Downloadable!]
  4. Larry Epstein & Martin Schneider, 2006. "Learning Under Ambiguity," RCER Working Papers 527, University of Rochester - Center for Economic Research (RCER). [Downloadable!]
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  5. Ralf Korn, 2008. "Optimal portfolios: new variations of an old theme," Computational Management Science, Springer, vol. 5(4), pages 289-304, October. [Downloadable!] (restricted)
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