Asset pricing model uncertainty and portfolio choice

2022. Finance Research Letters. Volume 45, 102144, https://doi.org/10.1016/j.frl.2021.102144

Erwin Hansen S, Ignacio Carrasco

Abstract:

We study how asset pricing uncertainty affects the performance of a Bayesian mean-variance investor’s portfolio allocation decisions. The investor allocates their wealth between a set of benchmark portfolios associated with a particular asset pricing model and a set of additional test assets. He centers their priors on model mispricing (alpha) around zero, but the true extent of mispricing is uncertain. When using recently introduced factor asset pricing models (Fama and French, 2015; and Hou et al., 2015), we find that allowing for mispricing uncertainty increases the point estimates of portfolio performance in most cases. However, their statistical significance is weaker.

Palabras claves: Model uncertainty, Factor models, Bayesian investor, Portfolio performance

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