Optimal portfolio with vector expected utility

Abstract

We study the optimal portfolio selected by an investor who conforms to Siniscalchi (2009)'s Vector Expected Utility's (VEU) axioms and who is ambiguity averse. To this end, we derive a mean-variance preference generalised to ambiguity from the second-order Taylor-Young expansion of the VEU certainty equivalent. We apply this Mean Variance Variability preference to the static two-assets portfolio problem and deduce asset allocation results which extend the mean-variance analysis to ambiguity in the VEU framework. Our criterion has attractive features: it is axiomatically wellfounded and analytically tractable, it is therefore well suited for applications to asset pricing as proved by a novel analysis of the home-bias puzzle with two ambiguous assets.JEL classification: D81, G11.

On booms that never bust: Ambiguity in experimental asset markets with bubbles

“…That is, we expect an ambiguity premium to arise, as is the case in standard ambiguity models accounting for the equity premium puzzle (see e.g., Chen and Epstein, 2002;Maenhout, 2004;Cao et al, 2005;Leippold et al, 2008;Ui, 2010;Ju and Miao, 2012), or the home equity bias (see e.g., Epstein and Miao, 2003;André 2014). This leads to our first conjecture.…”

“…The equity premium puzzle according to which stock returns are excessively high compared to bonds (Campbell and Cochrane, 1999) has been accounted for by the existence of an ambiguity premium on stocks which tends to depress prices and increase returns (see e.g., Chen and Epstein, 2002;Maenhout, 2004;Cao et al, 2005;Leippold et al, 2008;Ui, 2010;Ju and Miao, 2012). Using related arguments, several works have also relied on ambiguity aversion to account for the equity home bias by which traders under-invest in foreign assets (see e.g., Epstein and Miao, 2003;André 2014).…”