Dynamic Asset Allocation under Regime Switching, Predictability and Parameter Uncertainty

39 Pages Posted: 22 Oct 2012 Last revised: 28 Mar 2013

See all articles by Huy Thanh Vo

Huy Thanh Vo

Goethe University Frankfurt, Finance Department

Raimond Maurer

Goethe University Frankfurt - Finance Department

Date Written: March 25, 2013

Abstract

This paper solves the dynamic asset allocation problem under stock return predictability based on the dividend price ratio with regime shifts and parameter uncertainty in a fully Bayesian framework. Intertemporal hedging demands are simultaneously induced by predictability, regime shifts, parameter uncertainty, and learning about the regimes. Optimal policies display non-monotonic horizon effects whereby regime shifts tend to induce negative hedge demands in the short-run, while predictability induces positive hedge demands in the long-run. The economic costs of ignoring regime switching and predictability are high even in the light of regime and parameter uncertainty.

Keywords: Portfolio choice, Gibbs sampling, Dividend price ratio, Estimation risk

JEL Classification: G11, G17, C11

Suggested Citation

Vo, Huy Thanh and Maurer, Raimond, Dynamic Asset Allocation under Regime Switching, Predictability and Parameter Uncertainty (March 25, 2013). Available at SSRN: https://ssrn.com/abstract=2165029 or http://dx.doi.org/10.2139/ssrn.2165029

Huy Thanh Vo (Contact Author)

Goethe University Frankfurt, Finance Department ( email )

Grüneburgplatz 1
House of Finance
Frankfurt, 60323
Germany

Raimond Maurer

Goethe University Frankfurt - Finance Department ( email )

Theodor-W.-Adorno-Platz 3
House of Finance
Frankfurt, 60323
Germany

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