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Model Risk and Disappointment Aversion

Author

Listed:
  • Hasan Fallahgoul

    (Monash University)

  • Loriano Mancini

    (USI Lugano - Institute of Finance; Swiss Finance Institute)

  • Stoyan V. Stoyanov

    (Stony Brook University)

Abstract

Extensions of utility functions sensitive to the tail behavior of the portfolio return distribution may not be approximated reliably through higher-order moment expansions and require specifying a complete distribution. This, however, implies that an optimal allocation can be adversely influenced by an incorrect distribution specification. We develop a novel approach for model risk assessment based on a projection method which is applied to portfolio construction. In an out-of-sample empirical study, we find that the marginal utility gains of the optimal portfolio of a generalized disappointment aversion investor are remarkably robust to misspecifications in the marginal distributions but are very sensitive to the structural assumption of stock returns implemented through a factor model.

Suggested Citation

  • Hasan Fallahgoul & Loriano Mancini & Stoyan V. Stoyanov, 2018. "Model Risk and Disappointment Aversion," Swiss Finance Institute Research Paper Series 18-65, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp1865
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    More about this item

    Keywords

    Model risk; utility function; disappointment aversion;
    All these keywords.

    JEL classification:

    • C5 - Mathematical and Quantitative Methods - - Econometric Modeling
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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