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Learning About Predictability: The Effects of Parameter Uncertainty on Dynamic Asset Allocation

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  • Xia, Yihong
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    This paper examines the effects of uncertainty about the predictability of stock returns on optimal dynamic portfolio choice in a continuous time setting with a long horizon. Uncertainty about the predictive relation affects the optimal portfolio choice through dynamic learning, and leads to a rich set of relations between the optimal portfolio choice and the investment horizon. There are also substantial market timing elements in the optimal hedge demands, which are caused by stochastic covariance and variance terms arising from dynamic learning. The opportunity cost of ignoring predictability or learning is found to be quite substantial.

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    File URL: http://www.escholarship.org/uc/item/3167f8mz.pdf;origin=repeccitec
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    Paper provided by Anderson Graduate School of Management, UCLA in its series University of California at Los Angeles, Anderson Graduate School of Management with number qt3167f8mz.

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    Date of creation: 10 May 2000
    Handle: RePEc:cdl:anderf:qt3167f8mz
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    Web page: http://www.escholarship.org/repec/anderson_fin/

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