Robust portfolio rules and detection-error probabilities for a mean-reverting risk premium. (English) Zbl 1152.91535
Summary: I analyze the optimal intertemporal portfolio problem of an investor who worries about model misspecification and insists on robust decision rules when facing a mean-reverting risk premium. The desire for robustness lowers the total equity share, but increases the proportion of the intertemporal hedging demand. I present a methodology for calculation of detection-error probabilities, which is based on Fourier inversion of the conditional characteristic functions of the Radon – Nikodym derivatives. The quantitative effect of robustness is more modest than in i.i.d. settings, because model discrimination between the benchmark and the worst-case alternative model is easier, as indicated by the detection-error probabilities.
MSC:
| 91G10 | Portfolio theory |
| 60H10 | Stochastic ordinary differential equations (aspects of stochastic analysis) |
| 60H30 | Applications of stochastic analysis (to PDEs, etc.) |
Keywords:
portfolio choice; robustness; model uncertainty; intertemporal hedging; detection-error probabilityReferences:
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