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Model Misspecification and Underdiversification
Author(s) -
Uppal Raman,
Wang Tan
Publication year - 2003
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1046/j.1540-6261.2003.00612.x
Subject(s) - ambiguity , portfolio , econometrics , economics , variance (accounting) , marginal distribution , distribution (mathematics) , joint probability distribution , post modern portfolio theory , portfolio optimization , financial economics , replicating portfolio , mathematics , statistics , computer science , mathematical analysis , accounting , random variable , programming language
In this paper, we study intertemporal portfolio choice when an investor accounts explicitly for model misspecification. We develop a framework that allows for ambiguity about not just the joint distribution of returns for all stocks in the portfolio, but also for different levels of ambiguity for the marginal distribution of returns for any subset of these stocks. We find that when the overall ambiguity about the joint distribution of returns is high, then small differences in ambiguity for the marginal return distribution will result in a portfolio that is significantly underdiversified relative to the standard mean‐variance portfolio.