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Uncertainty Aversion, Robust Control and Asset Holdings

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Author Info
Giannis Vardas (Department of Economics, University of Crete, Greece)
Anastasios Xepapadeas () (Department of Economics, University of Crete, Greece)

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Abstract

Optimal portfolio rules are derived under uncertainty aversion by formulating the portfolio choice problem as a robust control problem. The robust portfolio rule indicates that the total holdings of risky assets as a proportion of the investor’s wealth could increase as compared to the holdings under the Merton rule, which is the standard risk aversion case. In particular, with two risky assets and one risk-free asset, we show that uncertainty aversion could lead to an increase in the holdings of the one risky asset, accompanied by a reduction in the holdings of the other risky asset. Furthermore, in the optimal robust portfolio the investor may increase the holdings of the asset for which there is or less ambiguity, and reduce the holdings of the asset for which there is more ambiguity, a result that might provide an explanation of the home bias puzzle.

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Publisher Info
Paper provided by University of Crete, Department of Economics in its series Working Papers with number 0402.

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Length: 36 pages
Date of creation: 00 Feb 2004
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Handle: RePEc:crt:wpaper:0402

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Related research
Keywords: Uncertainty Aversion Model Misspecification Robust Control Portfolio Choice Models

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Find related papers by JEL classification:
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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  17. Angel Serrat, 2001. "A Dynamic Equilibrium Model of International Portfolio Holdings," Econometrica, Econometric Society, vol. 69(6), pages 1467-1489, November. [Downloadable!] (restricted)
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  1. Giannis Vardas & Anastasios Xepapadeas, 2004. "Uncertainty Aversion and Robust Portfolio Choices," Working Papers 0408, University of Crete, Department of Economics. [Downloadable!]
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