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Variable Selection for Portfolio Choice

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  • Yacine AÏT-SAHALIA,

    (Princeton University & NBER)

  • Michael W. BRANDT

    (Wharton School, University of Pennsylvania & NBER)

Abstract

We study asset allocation when the conditional moments of returns are partly predictable. Rather than first model the return distribution and subsequently characterize the portfolio choice, we determine directly the dependence of the optimal portfolio weights on the predictive variables. We combine the predictors into a single index that best captures time-variations in investment opportunities. This index helps investors determine which economic variables they should track and, more importantly, in what combination. We consider investors with both expected utility (mean-variance and CRRA) and non-expected utility (ambiguity aversion and prospect theory) objectives and characterize their market-timing, horizon effects, and hedging demands.

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Bibliographic Info

Paper provided by International Center for Financial Asset Management and Engineering in its series FAME Research Paper Series with number rp34.

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Date of creation: Feb 2001
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Handle: RePEc:fam:rpseri:rp34

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