Robust Portfolio Rules and Asset Pricing

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ID: 305895
2004
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Abstract
I present a new approach to the dynamic portfolio and consumption problem of an investor who worries about model uncertainty (in addition to market risk) and seeks robust decisions along the lines of Anderson, Hansen, and Sargent (2002). In accordance with max-min expected utility, a robust investor insures against some endogenous worst case. I first show that robustness dramatically decreases the demand for equities and is observationally equivalent to recursive preferences when removing wealth effects. Unlike standard recursive preferences, however, robustness leads to environment-specific "effective" risk aversion. As an extension, I present a closed-form solution for the portfolio problem of a robust Duffie-Epstein-Zin investor. Finally, robustness increases the equilibrium equity premium and lowers the risk-free rate. Reasonable parameters generate a 4% to 6% equity premium.
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openalex_W2131387435 Use this key to autocite in the manuscript while using SciMatic Manuscript Manager or Thesis Manager
Authors Pascal J. Maenhout
Journal review of financial studies
Year 2004
DOI
10.1093/rfs/hhh003
URL
https://doi.org/10.1093/rfs/hhh003
Keywords Keywords not found

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