Model Risk and Disappointment Aversion

Hasan Fallahgoul, Loriano Mancini and Stoyan V. Stoyanov
Additional contact information
Hasan Fallahgoul: Monash University
Loriano Mancini: USI Lugano - Institute of Finance; Swiss Finance Institute
Stoyan V. Stoyanov: Stony Brook University

No 18-65, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: Extensions of utility functions sensitive to the tail behavior of the portfolio return distribution may not be approximated reliably through higher-order moment expansions and require specifying a complete distribution. This, however, implies that an optimal allocation can be adversely influenced by an incorrect distribution specification. We develop a novel approach for model risk assessment based on a projection method which is applied to portfolio construction. In an out-of-sample empirical study, we find that the marginal utility gains of the optimal portfolio of a generalized disappointment aversion investor are remarkably robust to misspecifications in the marginal distributions but are very sensitive to the structural assumption of stock returns implemented through a factor model.

Keywords: Model risk; utility function; disappointment aversion (search for similar items in EconPapers)
JEL-codes: C5 G12 (search for similar items in EconPapers)
Pages: 40 pages
Date: 2018-07
New Economics Papers: this item is included in nep-rmg and nep-upt
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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp1865

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