How much should life-cycle investors adapt their behavior when confronted with model uncertainty?

I investigate a dynamic life-cycle strategic asset allocation and consumption problem under model uncertainty, where both inflation rate and income growth rate are assumed to be estimated with errors. I present a feasible boundary for the uncertainty aversion parameter, which measures the investor’s preference for robustness using econometric theory. I derive a closed-form solution for a robust investor characterized by min-max utility preference to insure against the worst case scenario. Robustness dramatically increases the demand for the long-term bonds when the instantaneous inflation rate is low.

Netspar, Network for Studies on Pensions, Aging and Retirement, is a thinktank and knowledge network. Netspar is dedicated to promoting a wider understanding of the economic and social implications of pensions, aging and retirement in the Netherlands and Europe.


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