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A Simulation Approach to Dynamic Portfolio Choice with an Application to Learning About Return Predictability

A Simulation Approach to Dynamic Portfolio Choice with an Application to Learning About Return... We present a simulation-based method for solving discrete-time portfolio choice problems involving non-standard preferences, a large number of assets with arbitrary return distribution, and, most importantly, a large number of state variables with potentially path-dependent or non-stationary dynamics. The method is flexible enough to accommodate intermediate consumption, portfolio constraints, parameter and model uncertainty, and learning. We first establish the properties of the method for the portfolio choice between a stock index and cash when the stock returns are either iid or predictable by the dividend yield. We then explore the problem of an investor who takes into account the predictability of returns but is uncertain about the parameters of the data generating process. The investor chooses the portfolio anticipating that future data realizations will contain useful information to learn about the true parameter values. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Review of Financial Studies Oxford University Press

A Simulation Approach to Dynamic Portfolio Choice with an Application to Learning About Return Predictability

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Publisher
Oxford University Press
Copyright
© The Author 2005. Published by Oxford University Press. All rights reserved. For Permissions, please email: journals.permissions@oupjournals.org
ISSN
0893-9454
eISSN
1465-7368
DOI
10.1093/rfs/hhi019
Publisher site
See Article on Publisher Site

Abstract

We present a simulation-based method for solving discrete-time portfolio choice problems involving non-standard preferences, a large number of assets with arbitrary return distribution, and, most importantly, a large number of state variables with potentially path-dependent or non-stationary dynamics. The method is flexible enough to accommodate intermediate consumption, portfolio constraints, parameter and model uncertainty, and learning. We first establish the properties of the method for the portfolio choice between a stock index and cash when the stock returns are either iid or predictable by the dividend yield. We then explore the problem of an investor who takes into account the predictability of returns but is uncertain about the parameters of the data generating process. The investor chooses the portfolio anticipating that future data realizations will contain useful information to learn about the true parameter values.

Journal

The Review of Financial StudiesOxford University Press

Published: May 25, 2005

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