Equilibrium Portfolio Selection for Smooth Ambiguity Preferences

This paper investigates the equilibrium portfolio selection for smooth ambiguity preferences in a continuous-time market. The investor is uncertain about the risky asset’s drift term and updates the subjective belief according to the Bayesian rule. A verification theorem is established, and an equilibrium strategy can be decomposed into a myopic demand and two hedging demands. When the prior is Gaussian, we provide an equilibrium solution in closed form. Moreover, a puzzle in the numerical results is interpreted via an alternative representation of the smooth ambiguity preferences.

Funding: This work was supported by the National Key R&D Program of China [Grant 2020YFA0712700], the National Natural Science Foundation of China [Grants 11871036, 11901574, 12071146, 12271290, and 12371477], and the MOE Project of Key Research Institute of Humanities and Social Sciences [Grant 22JJD910003].