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RFS Advance Access originally published online on May 25, 2005
Review of Financial Studies 2005 18(3):831-873; doi:10.1093/rfs/hhi019
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© The Author 2005. Published by Oxford University Press. All rights reserved. For Permissions, please email: journals.permissions@oupjournals.org

A Simulation Approach to Dynamic Portfolio Choice with an Application to Learning About Return Predictability

Michael W. Brandt
Fuqua School of Business, Duke University, and NBER

Amit Goyal
Goizueta Business School, Emory University

Pedro Santa-Clara
The Anderson School, UCLA, and NBER

Jonathan R. Stroud
The Wharton School, University of Pennsylvania

Address correspondence to Amit Goyal, Goizueta Business School, Emory University, 1300 Clifton Rd., Atlanta, GA 30322-2722 or e-mail: Amit_Goyal{at}bus.emory.edu.

We present a simulation-based method for solving discrete-time portfolio choice problems involving non-standard preferences, a large number of assets with arbitrary return distribution, and, most importantly, a large number of state variables with potentially path-dependent or non-stationary dynamics. The method is flexible enough to accommodate intermediate consumption, portfolio constraints, parameter and model uncertainty, and learning. We first establish the properties of the method for the portfolio choice between a stock index and cash when the stock returns are either iid or predictable by the dividend yield. We then explore the problem of an investor who takes into account the predictability of returns but is uncertain about the parameters of the data generating process. The investor chooses the portfolio anticipating that future data realizations will contain useful information to learn about the true parameter values.


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