Portfolio allocation problems between risky and ambiguous assets
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This paper considers a portfolio allocation problem between a risky asset and an ambiguous asset, and investigates how greater ambiguity aversion influences the optimal proportion invested in the two assets. We derive several sufficient conditions under which greater ambiguity aversion decreases the optimal proportion invested in the ambiguous asset. Furthermore, we consider an international diversification problem as an application and show that ambiguity aversion partially resolves the home bias puzzle.
KeywordsUncertainty modelling Home bias puzzle Portfolio allocation problem Smooth ambiguity model Greater ambiguity aversion
JEL ClassificationG11 D81
We acknowledge an anonymous reviewer whose comments improved this paper substantially. We are grateful to Masamitsu Ohnishi and participants at Paris Financial Management Conference 2017 and the 2017 Annual Meeting of the Nippon Finance Association. Needless to say, we are responsible for any remaining errors. This research is financially supported by the JSPS KAKENHI Grant Nos. 26380240, 26380411, 26705004, 16H02026, 16H03619, 16K03558, 17K03806, and the Joint Research Program of KIER.
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