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Dynamic portfolio choice under ambiguity and regime switching mean returns

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  • Hening Liu

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Abstract

I examine a continuous-time intertemporal consumption and portfolio choice problem under ambiguity, where expected returns of a risky asset follow a hidden Markov chain. Investors with Chen and Epstein's (2002) recursive multiple priors utility possess a set of priors for unobservable investment opportunities. The optimal consumption and portfolio policies are explicitly characterized in terms of the Malliavin derivatives and stochastic integrals. When the model is calibrated to U.S. stock market data, I find that continuous Bayesian revisions under incomplete information generate ambiguity-driven hedging demands that mitigate intertemporal hedging demands. In addition, ambiguity aversion magnifies the importance of hedging demands in the optimal portfolio policies. Out-of-sample experiments demonstrate the economic importance of accounting for ambiguity.

Suggested Citation

  • Hening Liu, 2011. "Dynamic portfolio choice under ambiguity and regime switching mean returns," Post-Print hal-00781344, HAL.
  • Handle: RePEc:hal:journl:hal-00781344
    DOI: 10.1016/j.jedc.2010.12.012
    Note: View the original document on HAL open archive server: https://hal.archives-ouvertes.fr/hal-00781344
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    File URL: https://hal.archives-ouvertes.fr/hal-00781344/document
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    Cited by:

    1. Wang, Haijun, 2016. "Precautionary saving demand and consumption dynamics with the spirit of capitalism and regime switching," Journal of Mathematical Economics, Elsevier, vol. 64(C), pages 48-65.
    2. Escobar, Marcos & Ferrando, Sebastian & Rubtsov, Alexey, 2015. "Robust portfolio choice with derivative trading under stochastic volatility," Journal of Banking & Finance, Elsevier, vol. 61(C), pages 142-157.
    3. repec:eee:finlet:v:21:y:2017:i:c:p:178-185 is not listed on IDEAS
    4. Yuki Shigeta, 2016. "Optimal Switching under Ambiguity and Its Applications in Finance," Discussion papers e-16-005, Graduate School of Economics , Kyoto University.
    5. Yao, Haixiang & Chen, Ping & Li, Xun, 2016. "Multi-period defined contribution pension funds investment management with regime-switching and mortality risk," Insurance: Mathematics and Economics, Elsevier, vol. 71(C), pages 103-113.
    6. 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.
    7. Meglena Jeleva & Jean-Marc Tallon, 2016. "Ambiguïté, comportements et marchés financiers," Post-Print halshs-01109639, HAL.
    8. Rubtsov, Alexey, 2016. "Model misspecification and pricing of illiquid claims," Finance Research Letters, Elsevier, vol. 18(C), pages 242-249.
    9. repec:eee:dyncon:v:86:y:2018:i:c:p:49-71 is not listed on IDEAS
    10. Horváth, Ferenc, 2017. "Essays on robust asset pricing," Other publications TiSEM e54d7b33-1f27-4b0e-9f84-f, Tilburg University, School of Economics and Management.
    11. repec:kap:annfin:v:13:y:2017:i:1:d:10.1007_s10436-016-0291-7 is not listed on IDEAS

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