Dynamic optimal portfolio choice under time-varying risk aversion

Antonio Díaz and Carlos Esparcia

International Economics, 2021, vol. 166, issue C, 1-22

Abstract: In this paper, we empirically analyze the possible advantages of modelling a time-varying risk aversion that best fits investors’ behavior in the context of the optimal portfolio choice. We build optimal dynamic portfolios by focusing on the estimation of a time-varying relative risk aversion parameter (RRA). Conditional univariate and multivariate models, such as GARCH, GARCH-M and DCC-GARCH, for modelling the optimal portfolio choice and the RRA parameter are implemented. As a model validation tool, the realized performance and downside risk exposure of these portfolios one month ahead is compared to that resulting from implementing a constant risk aversion parameter. The Ledoit and Wolf (2008) test provides robustness to our results and reveals the average outperformance of the dynamic risk aversion strategy over others as the constant risk aversion or the passive management strategies.

Keywords: Optimal portfolio choice; Time-varying risk aversion; RRA; Market risk premium; GARCH models (search for similar items in EconPapers)
JEL-codes: C58 G01 G11 G41 (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:inteco:v:166:y:2021:i:c:p:1-22

DOI: 10.1016/j.inteco.2021.02.002

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