Return Predictability, Model Uncertainty, and Robust Investment

Manuel Lukas ()
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Manuel Lukas: Aarhus University and CREATES, Postal: Bartholins Allé 10, 8000 Aarhus C, Denmark

CREATES Research Papers from Department of Economics and Business Economics, Aarhus University

Abstract: Stock return predictability is subject to great uncertainty. In this paper we use the model confidence set approach to quantify uncertainty about expected utility from investment, accounting for potential return predictability. For monthly US data and six representative return prediction models, we find that confidence sets are very wide, change significantly with the predictor variables, and frequently include expected utilities for which the investor prefers not to invest. The latter motivates a robust investment strategy maximizing the minimal element of the confidence set. The robust investor allocates a much lower share of wealth to stocks compared to a standard investor.

Keywords: Return predictability; Model uncertainty; Model confidence set; Portfolio choice; Loss function (search for similar items in EconPapers)
JEL-codes: C52 C53 G11 G17 (search for similar items in EconPapers)
Pages: 31
Date: 2011-11-26
New Economics Papers: this item is included in nep-ecm, nep-for and nep-upt
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Persistent link: https://EconPapers.repec.org/RePEc:aah:create:2011-42

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