Portfolio inertia and [ epsilon ] - contaminations

This paper analyzes investors’ portfolio selection problems in a two-period dynamic model of Knightian uncertainty. We account for the existence of portfolio inertia in this two-period framework. Furthermore, by incorporating investors’ updating behavior, we analyze how new observation in the first period will affect investors’ behavior. By this analysis, we show that new observation in the first period will expand portfolio inertia in the second period compared with the case in which new observation has not been gained in the first period if the degree of Knightian uncertainty is sufficiently large. I would like to thank Hiroyuki Ozaki for his encouragement. I am also grateful to Akihiko Matsui for his comments and discussions on this work. I appreciate Satoru Takahashi as well as seminar participants at Macroeconomics Workshop (Osaka University) for their comments on this work. Needless to say, I am responsible for any remaining errors. I gratefully acknowledge the financial support from the 21st century COE program (Osaka University). e-mail: [email protected]