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RFS Advance Access published online on March 16, 2006
Review of Financial Studies, 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

Article

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

Jaksa Cvitanic 1, Ali Lazrak 2, Lionel Martellini 3, and Fernando Zapatero 4 *
1 Division of Humanities and Social Sciences, California Institute of Technology
2 Sauder School of Business, University of British Columbia
3 Finance Department, EDHEC
4 Marshall School of Business, University of Southern California, Los Angeles, CA 90089-1427

* To whom correspondence should be addressed.
Fernando Zapatero, E-mail: fzapatero{at}marshall.usc.edu


  Abstract

We derive a closed-form solution for the optimal portfolio of a non-myopic 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.


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