Dynamic Portfolio Choice under Model Uncertainty

This paper studies the effect of uncertainty about stochastic diffusion model on dynamic portfolio choice of an investor who maximizes utility of terminal portfolio wealth. It applies stochastic control method to obtain the closed-form solution of optimal dynamic portfolio, and uses the Bayesian rule to estimate the model parameters to do an empirical study on two different samples of Shanghai exchange composite index. Results show, model uncertainty results in positive or negative hedging demand of portfolio, which depends on investor´s attitude toward risk; the effect of model uncertainty is more significant with the increasing of investment horizon, the decreasing of investor´s risk-aversion degree, and the decreasing of information; return´s predictability enhances the effect of model uncertainty.