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Uncertainty Aversion, Robust Control and Asset Holdings

Giannis Vardas () and Anastasios Xepapadeas ()

No 402, Working Papers from University of Crete, Department of Economics

Abstract: Optimal portfolio rules are derived under uncertainty aversion by formulating the portfolio choice problem as a robust control problem. The robust portfolio rule indicates that the total holdings of risky assets as a proportion of the investor’s wealth could increase as compared to the holdings under the Merton rule, which is the standard risk aversion case. In particular, with two risky assets and one risk-free asset, we show that uncertainty aversion could lead to an increase in the holdings of the one risky asset, accompanied by a reduction in the holdings of the other risky asset. Furthermore, in the optimal robust portfolio the investor may increase the holdings of the asset for which there is or less ambiguity, and reduce the holdings of the asset for which there is more ambiguity, a result that might provide an explanation of the home bias puzzle.

Keywords: Uncertainty Aversion; Model Misspecification; Robust Control; Portfolio Choice Models (search for similar items in EconPapers)
JEL-codes: D81 G11 (search for similar items in EconPapers)
Pages: 36 pages
Date: 2004-02
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http://economics.soc.uoc.gr/wpa/docs/Vardas_Xepapad_Subm_JET_Feb04.pdf First version (application/pdf)

Related works:
Journal Article: Uncertainty aversion, robust control and asset holdings (2015) Downloads
Working Paper: Uncertainty Aversion, Robust Control and Asset Holdings (2004) Downloads
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