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RFS Advance Access originally published online on March 16, 2006
Review of Financial Studies 2006 19(4):1113-1156; doi:10.1093/rfs/hhj039
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© The Author 2006. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For permissions, please email: journals.permissions@oxfordjournals.org.

Dynamic Portfolio Choice with Parameter Uncertainty and the Economic Value of Analysts’ Recommendations

Jaksa Cvitanic
Division of Humanities and Social Sciences, California Institute of Technology

Ali Lazrak
Sauder School of Business, University of British Columbia

Lionel Martellini
Finance Department, EDHEC

Fernando Zapatero
Marshall School of Business, University of Southern California

Address correspondence to Fernando Zapatero, FBE, Marshall School of Business, USC, Los Angeles, CA 90089-1427, or email: fzapatero{at}marshall.usc.edu.

We derive a closed-form solution for the optimal portfolio of a nonmyopic utility maximizer who has incomplete information about the alphas or abnormal returns of risky securities. We show that the hedging component induced by learning about the expected return can be a substantial part of the demand. Using our methodology, we perform an "ex ante" empirical exercise, which shows that the utility gains resulting from optimal allocation are substantial in general, especially for long horizons, and an "ex post" empirical exercise, which shows that analysts’ recommendations are not very useful. (JEL C61, G11, G24)


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