Is stochastic volatility relevant for dynamic portfolio choice under ambiguity?

Correia da silva, Joao and Gonçalo, Faria (2016) Is stochastic volatility relevant for dynamic portfolio choice under ambiguity? European Journal of Finance. (In Press)

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Official URL: http://tse-fr.eu/pub/29820

Abstract

Literature on dynamic portfolio choice has been finding that volatility risk has low impact on portfolio choice. For example, using long-run US data, Chacko and Viceira [2005. “Dynamic Consumption and Portfolio Choice with Stochastic Volatility in Incomplete Markets.” The Review of Financial Studies 18 (4): 1369–1402] 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 US 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 on the short-term risk–return characteristics of the risky asset.

Item Type: Article
Language: English
Date: 2016
Refereed: Yes
Subjects: B- ECONOMIE ET FINANCE
Divisions: TSE-R (Toulouse)
Site: UT1
Date Deposited: 05 Nov 2015 15:11
Last Modified: 07 Mar 2018 13:23
OAI ID: oai:tse-fr.eu:29820
URI: http://publications.ut-capitole.fr/id/eprint/18593

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