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Ambiguity, Risk and Portfolio Choice under Incomplete Information

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  • Jianjun Miao

    (Department of Economics, Boston University)

Abstract

This paper studies optimal consumption and portfolio choice in a Mertonstyle model with incomplete information when there is a distinction between ambiguity and risk. The latter distinction is afforded by adoption of recursive multiple-priors utility. The fundamental issues are: (i) How does the agent optimally estimate the unobservable processes as new information arrives over time? (ii) What are the effects of ambiguity and incomplete information on behavior? This paper shows that it is optimal to first use any prior to perform Bayesian estimation and then to maximize expected utility with that prior based on the resulting estimates. Finally, the paper shows that a hedging demand arises that is affected by both ambiguity and estimation risk.

Suggested Citation

  • Jianjun Miao, 2009. "Ambiguity, Risk and Portfolio Choice under Incomplete Information," Annals of Economics and Finance, Society for AEF, vol. 10(2), pages 257-279, November.
  • Handle: RePEc:cuf:journl:y:2009:v:10:i:2:p:257-279
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Nengjiu Ju & Jianjun Miao, 2012. "Ambiguity, Learning, and Asset Returns," Econometrica, Econometric Society, vol. 80(2), pages 559-591, March.
    2. repec:eee:finlet:v:21:y:2017:i:c:p:178-185 is not listed on IDEAS
    3. Miao, Jianjun & Wang, Neng, 2011. "Risk, uncertainty, and option exercise," Journal of Economic Dynamics and Control, Elsevier, vol. 35(4), pages 442-461, April.
    4. Maillet, Bertrand & Tokpavi, Sessi & Vaucher, Benoit, 2015. "Global minimum variance portfolio optimisation under some model risk: A robust regression-based approach," European Journal of Operational Research, Elsevier, vol. 244(1), pages 289-299.
    5. Dai, Darong, 2011. "Modeling the minimum time needed to economic maturity," MPRA Paper 40583, University Library of Munich, Germany, revised 08 Aug 2012.
    6. Massimo Guidolin & Francesca Rinaldi, 2013. "Ambiguity in asset pricing and portfolio choice: a review of the literature," Theory and Decision, Springer, vol. 74(2), pages 183-217, February.
    7. Weidong Xu & Hongyi Li & Chongfeng Wu, 2011. "A Robust General Equilibrium Stochastic Volatility Model with Recursive Preference Investors," Annals of Economics and Finance, Society for AEF, vol. 12(2), pages 217-231, November.
    8. Hui Chen & Nengjiu Ju & Jianjun Miao, 2014. "Dynamic Asset Allocation with Ambiguous Return Predictability," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 17(4), pages 799-823, October.
    9. Markus Leippold & Fabio Trojani & Paolo Vanini, 2008. "Learning and Asset Prices Under Ambiguous Information," Review of Financial Studies, Society for Financial Studies, vol. 21(6), pages 2565-2597, November.
    10. Martin Schneider, 2010. "The Research Agenda: Martin Schneider on Multiple Priors Preferences and Financial Markets," EconomicDynamics Newsletter, Review of Economic Dynamics, vol. 11(2), April.
    11. Hening Liu, 2011. "Dynamic portfolio choice under ambiguity and regime switching mean returns," Post-Print hal-00781344, HAL.
    12. Larry G. Epstein & Shaolin Ji, 2017. "Optimal Learning and Ellsberg's Urns," Papers 1708.01890, arXiv.org.
    13. Qian Lin & Frank Riedel, 2014. "Optimal consumption and portfolio choice with ambiguity," Papers 1401.1639, arXiv.org.
    14. Bertrand Maillet & Sessi Tokpavi & Benoit Vaucher, 2013. "Minimum Variance Portfolio Optimisation under Parameter Uncertainty: A Robust Control Approach," EconomiX Working Papers 2013-28, University of Paris Nanterre, EconomiX.
    15. Junfeng Qiu, 2011. "Bank money, aggregate liquidity, and asset prices," Annals of Economics and Finance, Society for AEF, vol. 12(2), pages 295-346, November.
    16. Haijun Wang & L. Steven Hou, 2015. "Robust Consumption and Portfolio Choice with Habit Formation, the Spirit of Capitalism and Recursive Utility," Annals of Economics and Finance, Society for AEF, vol. 16(2), pages 393-416, November.
    17. Hui Huang & Shunming Zhang, 2011. "The Distorted Theory of Rank-Dependent Expected Utility," Annals of Economics and Finance, Society for AEF, vol. 12(2), pages 233-263, November.
    18. Liu, Hening, 2011. "Dynamic portfolio choice under ambiguity and regime switching mean returns," Journal of Economic Dynamics and Control, Elsevier, vol. 35(4), pages 623-640, April.

    More about this item

    Keywords

    Ambiguity; Recursive multiple-priors utility; Incomplete information; Portfolio choice; Hedging; Estimation risk;

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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