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Permanent shocks, signal extraction, and portfolio selection

Nazliben,Kamil Korhan
; 
Rodriguez,Juan Carlos
Abstract
Recent empirical research in portfolio selection shows that investor’s allocation to risky assets is low at young ages and does not exhibit a clear pattern of change as investors grow old. We show that standard models in the current literature predict a large allocation to stocks because they implicitly assume that transitory shocks dominate the stock price dynamics, and study a portfolio selection model in which the stock price is driven by a transitory and a dominant permanent component. The model captures time variation in expected returns and generates asset allocations that are small relative to the ones obtained in the current literature, and less dependent on the investor’s horizon. We investigate our model under complete and incomplete information, and find that under incomplete information our results are stronger.
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Date
2018-07
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Tilburg University Research Output Collection
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Keywords
Portfolio Selection, Kalman Filter, Mean Reversion, G11 - Portfolio Choice ; Investment Decisions, G13 - Contingent Pricing ; Futures Pricing
Citation
Nazliben, K K & Rodriguez, J C 2018, 'Permanent shocks, signal extraction, and portfolio selection', Journal of Economic Dynamics & Control, vol. 92, pp. 47-68. https://doi.org/10.1016/j.jedc.2018.04.005
URI
https://hdl.handle.net/20.500.14602/68998
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