Is Stochastic Volatility relevant for Dynamic Portfolio Choice under Ambiguity?

• Gonçalo Faria ^[1] ; João Correia-da-Silva ^[1]
  1. [1] Universidade Do Porto

     Universidade Do Porto

     Santo Ildefonso, Portugal

     
• Localización: Working paper series ( RGEA ), Nº. 5, 2012
• Idioma: inglés
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• Resumen

  • Literature on dynamic portfolio choice has been nding 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 nd that ambiguity impacts portfolio choice, with the relevant channel being the return process.

    Ambiguity about the volatility process is only relevant if, through a specic correlation structure, it also induces ambiguity about the return process. Using the same long-run U.S. data, we nd 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