Asset Allocation Under Distribution Uncertainty

55 Pages Posted: 20 Apr 2011 Last revised: 18 Jun 2011

See all articles by Marcin T. Kacperczyk

Marcin T. Kacperczyk

Imperial College London - Accounting, Finance, and Macroeconomics; Centre for Economic Policy Research (CEPR)

Paul Damien

University of Texas at Austin - McCombs School of Business

Date Written: April 18, 2011

Abstract

This paper shows how uncertainty about the type of return distribution (distribution uncertainty) can be incorporated in asset allocation decisions by using a novel, Bayesian semiparametric approach. To evaluate the economic importance of distribution uncertainty, the extent of changes in ex-ante optimal asset allocations of investors who factor in distribution uncertainty into their portfolio model is examined. The key findings are: (a) distribution uncertainty is highly time varying; (b) compared to investors facing parameter uncertainty, investors under distribution uncertainty, on average, allocate less money to risky assets; their allocations are less variable; and their certainty-equivalent losses from ignoring distribution uncertainty can be economically significant; (c) portfolio strategies of such investors generate statistically higher returns, even after controlling for common factors.

Keywords: Asset Allocation, Distribution Uncertainty, Bayesian Semiparametric Model

JEL Classification: G11, G12, C11, C14, C15

Suggested Citation

Kacperczyk, Marcin T. and Damien, Paul, Asset Allocation Under Distribution Uncertainty (April 18, 2011). McCombs Research Paper Series No. IROM-01-11, Available at SSRN: https://ssrn.com/abstract=1814526 or http://dx.doi.org/10.2139/ssrn.1814526

Marcin T. Kacperczyk (Contact Author)

Imperial College London - Accounting, Finance, and Macroeconomics ( email )

South Kensington campus
London SW7 2AZ
United Kingdom

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Paul Damien

University of Texas at Austin - McCombs School of Business ( email )

Austin, TX 78712
United States

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