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Asian Review of Financial Research, Vol., No..
pp.2496~2564
pp.2496~2564
Learning under Ambiguous Reversion
Hongseok Choi Republic of Korea Air Force Academy; Cheongju, Chungbuk 360-849, Republic of Korea
"It is now widely accepted that excess returns are predictable" (Lettau and Lud- vigson, 2001). However, there also have been authors nding otherwise, claiming that most of the predictive models are \unstable or even spurious" (Welch and Goyal, 2008). This paper proposes a model of learning through which we can investigate the behav- ior of an investor under such ambiguous circumstances. The proposed model describes how observations are translated into a set of probability measures that represents the investor's view of the immediate future; and I explicitly characterize the set's evolution up to a system of dierential equations that generalizes the Kalman-Bucy lter in the presence of ambiguity. The model of learning is then applied to the portfolio choice problem of a log investor; and learning under ambiguity is seen to have a signicant eect on hedging demand|under a reasonable calibration, the optimal demand for the risky asset at zero instantaneous equity premium decreases, as the investor loses condence, by half of wealth.
Hongseok Choi
"It is now widely accepted that excess returns are predictable" (Lettau and Lud- vigson, 2001). However, there also have been authors nding otherwise, claiming that most of the predictive models are \unstable or even spurious" (Welch and Goyal, 2008). This paper proposes a model of learning through which we can investigate the behav- ior of an investor under such ambiguous circumstances. The proposed model describes how observations are translated into a set of probability measures that represents the investor's view of the immediate future; and I explicitly characterize the set's evolution up to a system of dierential equations that generalizes the Kalman-Bucy lter in the presence of ambiguity. The model of learning is then applied to the portfolio choice problem of a log investor; and learning under ambiguity is seen to have a signicant eect on hedging demand|under a reasonable calibration, the optimal demand for the risky asset at zero instantaneous equity premium decreases, as the investor loses condence, by half of wealth.