A two-period model with portfolio choice: Understanding results from different solution methods

- We present a stylized two period model of portfolio choice.
- We compare the solutions of Devereux-Sutherland and Judd-Guu with a nonlinear solution.
- The true portfolio solution depends on the size of uncertainty.
- The Judd-Guu method captures this dependence well.
- The Devereux-Sutherland solution is unaffected by changes in the size of uncertainty.

Using a stylized two-period model we compare portfolio solutions from two local solution approaches-the approach of Judd and Guu (2001) and the approach of Devereux and Sutherland (2010, 2011)-with the true nonlinear portfolio solution.