The Robust Merton Problem of an Ambiguity Averse Investor

Sara Biagini and Mustafa Pinar

Papers from arXiv.org

Abstract: We derive a closed form portfolio optimization rule for an investor who is diffident about mean return and volatility estimates, and has a CRRA utility. The novelty is that confidence is here represented using ellipsoidal uncertainty sets for the drift, given a volatility realization. This specification affords a simple and concise analysis, as the optimal portfolio allocation policy is shaped by a rescaled market Sharpe ratio, computed under the worst case volatility. The result is based on a max-min Hamilton-Jacobi-Bellman-Isaacs PDE, which extends the classical Merton problem and reverts to it for an ambiguity-neutral investor.

Date: 2015-02
New Economics Papers: this item is included in nep-upt
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