Dynamic portfolio selection with mispricing and model ambiguity (Q2018555)

The authors introduce a financial market model with mispriced stocks. A robust problem for an ambiguity-averse investor with constant relative risk aversion utility is presented and solved under the market with mispricing and constant risk premium. They investigate the robust optimal strategies under observed and unobserved mean-reverting stochastic risk premium. Finally, they provide empirical examples and discuss the utility losses for ignoring mispricing and ignoring ambiguity: the optimal strategy is dependent on the liquidity parameters for stocks, which are very difficult to estimate. Thus, a wise investor should consider ambiguity on the mispricing model when making decisions about investing in the mispriced assets.