This paper investigates the equilibrium portfolio selection for smooth ambiguity preferences in a continuous-time market. The investor is uncertain about the risky asset’s drift term and updates the subjective belief according to the Bayesian rule. A verification theorem is established, and an equilibrium strategy can be decomposed into a myopic demand and two hedging demands. When the prior is Gaussian, we provide an equilibrium solution in closed form. Moreover, a puzzle in the numerical results is interpreted via an alternative representation of the smooth ambiguity preferences.

Publication:

MATHEMATICS OF OPERATIONS RESEARCH

http://dx.doi.org/10.1287/moor.2023.0112

Author:

Guohui Guan

Center for Applied Statistics and School of Statistics, Renmin University of China, Beijing 100872, China

Zongxia Liang

Department of Mathematical Sciences, Tsinghua University, Beijing 100084, China

Jianming Xia

Key Laboratory of Random Complex Structures and Data Science (RCSDS), National Center for Mathematics and Interdisciplinary Sciences (NCMIS), Academy of Mathematics and Systems Science, Chinese Academy of Sciences, Beijing 100190, China

Corresponding author

guangh@ruc.edu.