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Is Stochastic Volatility relevant for Dynamic Portfolio Choice under Ambiguity?

Gonçalo Faria () and Joao Correia-da-Silva

FEP Working Papers from Universidade do Porto, Faculdade de Economia do Porto

Abstract: Literature on dynamic portfolio choice has been finding that volatility risk has low impact on portfolio choice. For example, using long-run U.S. data, Chacko and Viceira (2005) found that intertemporal hedging demand (required by investors for protection against adverse changes in volatility) is empirically small even for highly risk-averse investors. We want to assess if this continues to be true in the presence of ambiguity. Adopting robust control and perturbation theory techniques, we study the problem of a long-horizon investor with recursive preferences that faces ambiguity about the stochastic processes that generate the investment opportunity set. We find that ambiguity impacts portfolio choice, with the relevant channel being the return process. Ambiguity about the volatility process is only relevant if, through a specific correlation structure, it also induces ambiguity about the return process. Using the same long-run U.S. data, we find that ambiguity about the return process may be empirically relevant, much more than ambiguity about the volatility process. Anyway, intertemporal hedging demand is still very low: investors are essentially focused in the short-term risk-return characteristics of the risky asset.

Keywords: Dynamic Portfolio Choice; Stochastic Volatility; Ambiguity; Robust Control; Perturbation Theory (search for similar items in EconPapers)
JEL-codes: C61 D81 E21 G11 (search for similar items in EconPapers)
Pages: 29 pages
Date: 2012-10
New Economics Papers: this item is included in nep-ore and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Journal Article: Is stochastic volatility relevant for dynamic portfolio choice under ambiguity? (2016) Downloads
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