| This dissertation investigates the economic value of data-generating process uncertainty, asymmetries in stock returns and bull and bear markets from an investment perspective. The first essay evaluates the economic significance of incorporating data-generating process (DGP) uncertainty in making investment decisions; the second essay provides a way of formally assessing the economic value of asymmetries in stock returns; the third essay evaluates the economic significance of uncertainty about bull and bear markets.; In the first essay, my co-author and I propose a novel way to incorporate uncertainty about the DGP, encountered by investors when the usual normality assumption is firmly rejected by the data, into investors' portfolio analysis. We find that accounting for fat tails leads to nontrivial changes in both parameter estimates and optimal portfolio weights, but the certainty-equivalent losses associated with ignoring fat tails are small. This suggests that the normality assumption works well in evaluating portfolio performance for mean-variance investors.; In the second essay, my co-authors and I provide a model-free test for asymmetric correlations that suggest stocks tend to have greater correlations with the market when the market goes down than when it goes up. Applying our methodology to three portfolios grouped by size, Fama and French's size and book-to-market, and industry, we find that asymmetries show up in sample estimates for all the portfolios, but they are statistically significant primarily for small size portfolios. Nevertheless, asymmetries are of substantial economic importance for an investor who switches her symmetry belief into an asymmetric one, irrespective of the portfolios.; In the third essay, I propose a novel way to model uncertainty about bull and bear markets. I find that risks and returns vary greatly across regimes. More importantly, the certainty-equivalent losses associated with ignoring bull and bear markets are fairly large. Therefore, the economic value of incorporating regime-switching is substantial from an investment perspective. |
