Associate Professor Xianming Sun,Executive Deputy Director of the Base, has published a collaborative paper titled "Robust investment strategies with two risky assets" in Journal of Economic Dynamics and Control

Abstract:

In reality, investors are uncertain about the dynamics of the riskyasset returns(e.g., the expected returns and the correlation between the returns of two risky assets). Consequently, investors make robust investment decisions with special concerns on the expected returns and correlations. In this paper, we propose a hierarchical rule for robust investment between two risky assets: select the relatively safe asset first and then decide how much to invest in the relatively risky asset to hedge the ambiguity embedded in the relatively safe asset. After introducing criteria for relative riskiness and cross-hedging for investors with a constant relative risk averse (CRRA) utility, we find that a typical investor would equally invest in the two risky assets regardless of their correlation when they are indistinguishable from the riskiness perspective. Furthermore, the investor will take a long or short position on the relatively risky asset if it can work as the cross-hedging instrument due to their correlation; otherwise, it will not be traded at all. These results provide a unified explanation for the observed "under-diversification", "home bias", and "portfolio inertia" in financial markets from the cross-hedging point of view.

Key Words: Robust investment, Ambiguity, Model uncertainty

Link: https://doi.org/10.1016/j.jedc.2021.104275

Teacher Profile

Xianming Sun, Ph.D., Executive Deputy Director of Innovation and Talent Base for Digital Technology and Finance, associate professor of Financial Engineering Department, Zhongnan University of Economics and Law, and master tutor. He was awarded as "Chutian Student" of Hubei Province and "Wenlan Young Scholar" of Zhongnan University of Economics and Law. His research interests include Financial Engineering, Financial Technology and related fields. He has published more than 10 papers in important academic journals such as the Journal of Economic Dynamics and Control, Journal of Futures Markets, Journal of Computational and Applied Mathematics, Computational Economics, Statistics and Probability Letters. He is currently leading research projects such as the National Natural Science Foundation of China and the Basic Research Funds of Central universities. The related research has won the Excellent Paper Award of the 16th China Financial Engineering Annual Conference (2017).