Robust Portfolio Choice with Ambiguity and Learning about Return Predictability

Branger Nicole, Larsen Linda, Munk Claus


Abstract
We analyze the optimal stock-bond portfolio under both learning and ambiguity aversion. Stock returns are predictable by an observable and an unobservablepredictor, and the investor has to learn about the latter. Furthermore, the investor is ambiguity-averse and has a preference for investment strategies that are robust to model misspecifications. We derive a closed-form solution for the optimal robust investment strategy. We find that both learning and ambiguity aversion impact the level and structure of the optimal stock investment. Suboptimal strategies resulting either from not learning or from not considering ambiguity can lead to economically significant losses.

Keywords
Return predictability; Portfolio choice; Ambiguity; Learning; Robust; control



Publication type
Research article (journal)

Peer reviewed
Yes

Publication status
Published

Year
2013

Journal
Journal of Banking and Finance

Volume
37

Issue
5

Start page
1397

End page
1411

Language
English

ISSN
0378-4266

DOI