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

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  • Xia, Yihong
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    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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    Bibliographic Info

    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 qt3167f8mz.

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    Date of creation: 10 May 2000
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    Handle: RePEc:cdl:anderf:qt3167f8mz

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    1. Brennan, Michael J. & Xia, Yihong, 1999. "Assessing Assets Pricing Anomalies," University of California at Los Angeles, Anderson Graduate School of Management qt3jx02532, Anderson Graduate School of Management, UCLA.
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    Cited by:
    1. Gollier Christian, 2004. "Optimal Dynamic Portfolio Risk with First-Order and Second-Order Predictability," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 4(1), pages 1-35, September.
    2. Massa, Massimo & Simonov, Andrei, 2005. "Is learning a dimension of risk?," Journal of Banking & Finance, Elsevier, vol. 29(10), pages 2605-2632, October.
    3. Jianjun Miao, 2009. "Ambiguity, Risk and Portfolio Choice under Incomplete Information," Annals of Economics and Finance, Society for AEF, vol. 10(2), pages 257-279, November.
    4. Brennan, Michael J. & Xia, Yihong, 2000. "Dynamic Asset Allocation under Inflation," University of California at Los Angeles, Anderson Graduate School of Management qt8p95456t, Anderson Graduate School of Management, UCLA.

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