Permanent shocks, signal extraction, and portfolio selection

Kamil Korhan Nazliben, Juan Carlos Rodriguez

Research output: Contribution to journalArticleScientificpeer-review

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.
Original languageEnglish
Pages (from-to)47-68
JournalJournal of Economic Dynamics and Control
Volume92
DOIs
Publication statusPublished - Jul 2018

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Signal Extraction
Portfolio Selection
Stock Prices
Incomplete Information
Shock
Asset Allocation
Empirical Research
Selection Model
Standard Model
Horizon
Predict
Dependent
Model
Permanent shock
Investors
Signal extraction
Portfolio selection
Stock prices
Incomplete information

Keywords

  • Portfolio Selection
  • Kalman Filter
  • Mean Reversion

Cite this

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Permanent shocks, signal extraction, and portfolio selection. / Nazliben, Kamil Korhan; Rodriguez, Juan Carlos.

In: Journal of Economic Dynamics and Control, Vol. 92, 07.2018, p. 47-68.

Research output: Contribution to journalArticleScientificpeer-review

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