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An optimal investment and consumption model with stochastic returns

โœ Scribed by Xikui Wang; Yanqing Yi

Publisher
John Wiley and Sons
Year
2009
Tongue
English
Weight
122 KB
Volume
25
Category
Article
ISSN
1524-1904

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โœฆ Synopsis

Abstract

We consider a financial market consisting of a risky asset and a riskless one, with a constant or random investment horizon. The interest rate from the riskless asset is constant, but the relative return rate from the risky asset is stochastic with an unknown parameter in its distribution. Following the Bayesian approach, the optimal investment and consumption problem is formulated as a Markov decision process. We incorporate the concept of risk aversion into the model and characterize the optimal strategies for both the power and logarithmic utility functions with a constant relative risk aversion (CRRA). Numerical examples are provided that support the intuition that a higher proportion of investment should be allocated to the risky asset if the mean return rate on the risky asset is higher or the risky asset return rate is less volatile. Copyright ยฉ 2008 John Wiley & Sons, Ltd.

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