Is Stochastic Volatility relevant for Dynamic Portfolio Choice under Ambiguity?
AbstractLiterature on dynamic portfolio choice has been finding that volatility risk has low impact on portfolio choice. For example, using long-run U.S. data, Chacko and Viceira (2005) found that intertemporal hedging demand (required by investors for protection against adverse changes in volatility) is empirically small even for highly risk-averse investors. We want to assess if this continues to be true in the presence of ambiguity. Adopting robust control and perturbation theory techniques, we study the problem of a long-horizon investor with recursive preferences that faces ambiguity about the stochastic processes that generate the investment opportunity set. We find that ambiguity impacts portfolio choice, with the relevant channel being the return process. Ambiguity about the volatility process is only relevant if, through a specific correlation structure, it also induces ambiguity about the return process. Using the same long-run U.S. data, we find that ambiguity about the return process may be empirically relevant, much more than ambiguity about the volatility process. Anyway, intertemporal hedging demand is still very low: investors are essentially focused in the short-term risk-return characteristics of the risky asset.
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Bibliographic InfoPaper provided by Universidade do Porto, Faculdade de Economia do Porto in its series FEP Working Papers with number 472.
Length: 29 pages
Date of creation: Oct 2012
Date of revision:
Dynamic Portfolio Choice; Stochastic Volatility; Ambiguity; Robust Control; Perturbation Theory;
Find related papers by JEL classification:
- C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-04-13 (All new papers)
- NEP-ORE-2013-04-13 (Operations Research)
- NEP-UPT-2013-04-13 (Utility Models & Prospect Theory)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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