Optimum consumption and portfolio rules in a continuous-time model☆
TL;DR: In this paper, the authors considered the continuous-time consumption-portfolio problem for an individual whose income is generated by capital gains on investments in assets with prices assumed to satisfy the geometric Brownian motion hypothesis, which implies that asset prices are stationary and lognormally distributed.
About: This article is published in Journal of Economic Theory.The article was published on 1971-12-01 and is currently open access. It has received 4952 citations till now. The article focuses on the topics: Geometric Brownian motion & Intertemporal portfolio choice.
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TL;DR: In this article, the concept of convex compactness is introduced and discussed, weaker than the classical notion of compactness, and a large class of subsets of topological vector spaces shares this property and that is can be used in lieu of the classical compactness in a variety of cases.
Abstract: The concept of convex compactness, weaker than the classical notion of compactness, is introduced and discussed. It is shown that a large class of convex subsets of topological vector spaces shares this property and that is can be used in lieu of compactness in a variety of cases. Specifically, we establish convex compactness for certain familiar classes of subsets of the set of positive random variables under the topology induced by convergence in probability. Two applications in infinite-dimensional optimization—attainment of infima and a version of the Minimax theorem—are given. Moreover, a new fixed-point theorem of the Knaster-Kuratowski-Mazurkiewicz-type is derived and used to prove a general version of the Walrasian excess-demand theorem.
60 citations
TL;DR: A generalization of the Merton's original problem of optimal consumption and portfolio choice for a single investor in an intertemporal economy using a novel transformation to produce closed form solutions for the value function and the optimal policies.
Abstract: We study a generalization of the Merton's original problem of optimal consumption and portfolio choice for a single investor in an intertemporal economy. The agent trades between a bond and a stock account and he may consume out of his bond holdings. The price of the bond is deterministic as opposed to the stock price which is modelled as a diffusion process. The main assumption is that the coefficients of the stock price diffusion are arbitrary nonlinear functions of the underlying process. The investor's goal is to maximize his expected utility from terminal wealth and/or his expected utility of intermediate consumption. The individual preferences are of Constant Relative Risk Aversion (CRRA) type for both the consumption stream and the terminal wealth. Employing a novel transformation, we are able to produce closed form solutions for the value function and the optimal policies. In the absence of intermediate consumption, the value function can be expressed in terms of a power of the solution of a homogeneous linear parabolic equation. When intermediate consumption is allowed, the value function is expressed via the solution of a non-homogeneous linear parabolic equation.
60 citations
TL;DR: In this article, the authors consider the portfolio optimization problem for an investor whose consumption rate process and terminal wealth are subject to downside constraints, and derive the optimal portfolio policy for a wide scale of utility functions.
Abstract: We consider the portfolio optimization problem for an investor whose consumption rate process and terminal wealth are subject to downside constraints. In the standard financial market model that consists of d risky assets and one riskless asset, we assume that the riskless asset earns a constant instantaneous rate of interest, r > 0, and that the risky assets are geometric Brownian motions. The optimal portfolio policy for a wide scale of utility functions is derived explicitly. The gradient operator and the Clark–Ocone formula in Malliavin calculus are used in the derivation of this policy. We show how Malliavin calculus approach can help us get around certain difficulties that arise in using the classical “delta hedging” approach.
60 citations
Cites background from "Optimum consumption and portfolio r..."
...The model under consideration here is that of a complete financial market as in Merton (1971), Karatzas (1989), and others, wherein there is one riskless asset and d (correlated) risky assets generated by d independent Brownian motions....
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TL;DR: In this paper, an approach to understand the nature of markets is modelled using methods of modern nonlinear nonequilibrium statistical mechanics, and explicit relationships are derived between variables describing these agents and the macroscopic market.
60 citations
TL;DR: In this paper, a consumption-based capital asset pricing model with state-dependent risk aversion is proposed and the corresponding risk premium includes consumption risk and the risk associated with variations in preferences.
Abstract: We propose a consumption-based capital asset pricing model with state-dependent risk aversion. The corresponding risk premium includes consumption risk and the risk associated with variations in preferences. Our model can be estimated without specifying the functional form linking risk aversion with state variables. The estimates are based on Markov chain Monte Carlo estimation of exact discrete-time parameterizations for linear diffusion processes. We find estimates for relative risk aversion that are reasonable by usual standards, correlated with both consumption and returns, and indicative of an additional preference risk of holding the assets.
60 citations
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TL;DR: In this paper, the combined problem of optimal portfolio selection and consumption rules for an individual in a continuous-time model was examined, where his income is generated by returns on assets and these returns or instantaneous "growth rates" are stochastic.
Abstract: OST models of portfolio selection have M been one-period models. I examine the combined problem of optimal portfolio selection and consumption rules for an individual in a continuous-time model whzere his income is generated by returns on assets and these returns or instantaneous "growth rates" are stochastic. P. A. Samuelson has developed a similar model in discrete-time for more general probability distributions in a companion paper [8]. I derive the optimality equations for a multiasset problem when the rate of returns are generated by a Wiener Brownian-motion process. A particular case examined in detail is the two-asset model with constant relative riskaversion or iso-elastic marginal utility. An explicit solution is also found for the case of constant absolute risk-aversion. The general technique employed can be used to examine a wide class of intertemporal economic problems under uncertainty. In addition to the Samuelson paper [8], there is the multi-period analysis of Tobin [9]. Phelps [6] has a model used to determine the optimal consumption rule for a multi-period example where income is partly generated by an asset with an uncertain return. Mirrless [5] has developed a continuous-time optimal consumption model of the neoclassical type with technical progress a random variable.
4,908 citations
Book•
01 Jan 1965
TL;DR: This book should be of interest to undergraduate and postgraduate students of probability theory.
Abstract: This book should be of interest to undergraduate and postgraduate students of probability theory.
3,597 citations
TL;DR: In this paper, the optimal consumption-investment problem for an investor whose utility for consumption over time is a discounted sum of single-period utilities, with the latter being constant over time and exhibiting constant relative risk aversion (power-law functions or logarithmic functions), is discussed.
Abstract: Publisher Summary This chapter reviews the optimal consumption-investment problem for an investor whose utility for consumption over time is a discounted sum of single-period utilities, with the latter being constant over time and exhibiting constant relative risk aversion (power-law functions or logarithmic functions). It presents a generalization of Phelps' model to include portfolio choice and consumption. The explicit form of the optimal solution is derived for the special case of utility functions having constant relative risk aversion. The optimal portfolio decision is independent of time, wealth, and the consumption decision at each stage. Most analyses of portfolio selection, whether they are of the Markowitz–Tobin mean-variance or of more general type, maximize over one period. The chapter only discusses special and easy cases that suffice to illustrate the general principles involved and presents the lifetime model that reveals that investing for many periods does not itself introduce extra tolerance for riskiness at early or any stages of life.
2,369 citations
Book•
17 Jan 2012
TL;DR: In this article, a book on stochastic stability and control dealing with Liapunov function approach to study of Markov processes is presented, which is based on the work of this article.
Abstract: Book on stochastic stability and control dealing with Liapunov function approach to study of Markov processes
1,293 citations
987 citations