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Learning About Predictability: The Effects of Parameter Uncertainty on Dynamic Asset Allocation

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Author Info
Yihong Xia (Anderson School of Management)
Abstract

This paper examines the effects of uncertainty about the predictability of stock returns on optimal dynamic portfolio choice in a continuous time setting with a long horizon. Uncertainty about the predictive relation affects the optimal portfolio choice through dynamic learning, and leads to a rich set of relations between the optimal portfolio choice and the investment horizon. There are also substantial market timing elements in the optimal hedge demands, which are caused by stochastic covariance and variance terms arising from dynamic learning. The opportunity cost of ignoring predictability or learning is found to be quite substantial.

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Paper provided by Anderson Graduate School of Management, UCLA in its series University of California at Los Angeles, Anderson Graduate School of Management with number 1057.

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Date of creation: 10 May 2000
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Handle: RePEc:cdl:anderf:1057

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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.:

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    Other versions:
  3. Summers, Lawrence H, 1986. " Does the Stock Market Rationally Reflect Fundamental Values?," Journal of Finance, American Finance Association, vol. 41(3), pages 591-601, July. [Downloadable!] (restricted)
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    Other versions:
  6. Gennotte, Gerard, 1986. " Optimal Portfolio Choice under Incomplete Information," Journal of Finance, American Finance Association, vol. 41(3), pages 733-46, July. [Downloadable!] (restricted)
  7. Kothari, S. P. & Shanken, Jay, 1997. "Book-to-market, dividend yield, and expected market returns: A time-series analysis," Journal of Financial Economics, Elsevier, vol. 44(2), pages 169-203, May. [Downloadable!] (restricted)
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    Other versions:
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    Other versions:
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  21. Andrew W. Lo, A. Craig MacKinlay, 1988. "Stock Market Prices do not Follow Random Walks: Evidence from a Simple Specification Test," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 1(1), pages 41-66. [Downloadable!] (restricted)
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    Other versions:
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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. Michael Brennan & Yihong Xia, 2000. "Dynamic Asset Allocation under Inflation," University of California at Los Angeles, Anderson Graduate School of Management 1069, Anderson Graduate School of Management, UCLA. [Downloadable!]
  2. Gollier, Christian, 2003. "Optimal Dynamic Portfolio Risk with First-Order and Second-Order Predictability," IDEI Working Papers 250, Institut d'Économie Industrielle (IDEI), Toulouse. [Downloadable!]
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