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Optimal Portfolio with Vector Expected Utility

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  • Eric André

    ()
    (AMSE - Aix-Marseille School of Economics - Aix-Marseille Univ. - Centre national de la recherche scientifique (CNRS) - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - Ecole Centrale Marseille (ECM))

Abstract

We study the optimal portfolio selected by an investor who conforms to Siniscalchi (2009)'s Vector Expected Utility's (VEU) axioms and who is ambiguity averse. To this end, we derive a mean-variance preference generalised to ambiguity from the second-order Taylor-Young expansion of the VEU certainty equivalent. We apply this Mean Variance Variability preference to the static two-assets portfolio problem and deduce asset allocation results which extend the mean-variance analysis to ambiguity in the VEU framework. Our criterion has attractive features: it is axiomatically well-founded and analytically tractable, it is therefore well suited for applications to asset pricing as proved by a novel analysis of the home-bias puzzle with two ambiguous assets.

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Paper provided by HAL in its series Working Papers with number halshs-00796482.

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Date of creation: Feb 2013
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Handle: RePEc:hal:wpaper:halshs-00796482

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Keywords: Vector Expected Utility; Ambiguity; Portfolio Choice; Home-bias Puzzle;

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  1. Fabio Maccheroni & Massimo Marinacci & Aldo Rustichini, 2006. "Ambiguity Aversion, Robustness, and the Variational Representation of Preferences," Econometrica, Econometric Society, Econometric Society, vol. 74(6), pages 1447-1498, November.
  2. Massimo Marinacci & Fabio Maccheroni & Aldo Rustichini & Marco Taboga, 2005. "Portfolio Selection with Monotone Mean-Variance Preferences," Finance, EconWPA 0502014, EconWPA.
  3. Larry G. Epstein & JianJun Miao, 2001. "A Two-Person Dynamic Equilibrium under Ambiguity," RCER Working Papers 478, University of Rochester - Center for Economic Research (RCER).
  4. Raman Uppal & Lorenzo Garlappi & Tan Wang, 2004. "Portfolio Selection with Parameter and Model Uncertainty: A Multi-Prior Approach," Money Macro and Finance (MMF) Research Group Conference 2004, Money Macro and Finance Research Group 54, Money Macro and Finance Research Group.
  5. Ghirardato, Paolo & Marinacci, Massimo, 2002. "Ambiguity Made Precise: A Comparative Foundation," Journal of Economic Theory, Elsevier, Elsevier, vol. 102(2), pages 251-289, February.
  6. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, American Finance Association, vol. 7(1), pages 77-91, 03.
  7. Daniel Ellsberg, 2000. "Risk, Ambiguity and the Savage Axioms," Levine's Working Paper Archive 7605, David K. Levine.
  8. David Schmeidler, 1989. "Subjective Probability and Expected Utility without Additivity," Levine's Working Paper Archive 7662, David K. Levine.
  9. Marciano Siniscalchi, 2007. "Vector Expected Utility and Attitudes toward Variation," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 1455, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  10. Segal, Uzi & Spivak, Avia, 1990. "First order versus second order risk aversion," Journal of Economic Theory, Elsevier, Elsevier, vol. 51(1), pages 111-125, June.
  11. Gollier, Christian, 2009. "Portfolio Choices and Asset Prices: The Comparative Statics of Ambiguity Aversion," TSE Working Papers, Toulouse School of Economics (TSE) 09-068, Toulouse School of Economics (TSE).
  12. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  13. Taboga, Marco, 2005. "Portfolio selection with two-stage preferences," Finance Research Letters, Elsevier, Elsevier, vol. 2(3), pages 152-164, September.
  14. Fabio Maccheroni & Massimo Marinacci & Doriana Ruffino, 2013. "Alpha as Ambiguity: Robust Mean‐Variance Portfolio Analysis," Econometrica, Econometric Society, Econometric Society, vol. 81(3), pages 1075-1113, 05.
  15. Mas-Colell, Andreu & Whinston, Michael D. & Green, Jerry R., 1995. "Microeconomic Theory," OUP Catalogue, Oxford University Press, Oxford University Press, number 9780195102680, October.
  16. Gilboa, Itzhak & Schmeidler, David, 1989. "Maxmin expected utility with non-unique prior," Journal of Mathematical Economics, Elsevier, vol. 18(2), pages 141-153, April.
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