Portfolio Inertia and Epsilon-Contaminations

This article 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 observing new information in the first period will affect investors’ behavior. By this analysis, we show that observing new information in the first period will expand portfolio inertia in the second period compared with the case in which observing new information has not been gained in the first period if the degree of Knightian uncertainty is sufficiently large.