Working Paper: NBER ID: w7284
Authors: Lubo Pastor; Robert F. Stambaugh
Abstract: We investigate the portfolio choices of mean-variance-optimizing investors who use sample evidence to update prior beliefs centered on either risk-based or characteristic-based pricing models. With dogmatic beliefs in such models and an unconstrained ratio of position size to capital, optimal portfolios can differ across models to economically significant degrees. The differences are substantially reduced by modest uncertainty about the models' pricing abilities. When the ratio of position size to capital is subject to realistic constraints, the differences in portfolios across models become even less important, nonexistent in some cases.
Keywords: No keywords provided
JEL Codes: G11; G12; C11
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| risk-based pricing model (G19) | optimal portfolio choices (G11) |
| characteristic-based pricing model (D49) | optimal portfolio choices (G11) |
| dogmatic beliefs in risk-based model (D80) | significant differences in optimal portfolios (G11) |
| dogmatic beliefs in characteristic-based model (C52) | significant differences in optimal portfolios (G11) |
| risk-based model assumptions about expected returns (G17) | optimal portfolio choices (G11) |
| characteristic-based model assumptions about expected returns (G17) | optimal portfolio choices (G11) |
| complete confidence in Daniel-Titman model (C59) | perceived equivalent loss (J17) |
| complete confidence in Fama-French model (C58) | perceived equivalent loss (J17) |
| uncertainty about pricing ability of models (D89) | decrease in perceived losses (G41) |
| margin requirements (G32) | diminish differences in portfolio choices (G11) |
| constraints imposed by market regulations (G18) | reduce economic significance of model differences (C59) |