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Kraft, Holger; Seifried, Frank Thomas; Steffensen, Mogens

Consumption-portfolio optimization with recursive utility in incomplete markets. (English) Zbl 1257.91042

Finance Stoch. 17, No. 1, 161-196 (2013).
Summary: In an incomplete market, we study the optimal consumption-portfolio decision of an investor with recursive preferences of Epstein-Zin type. Applying a classical dynamic programming approach, we formulate the associated Hamilton-Jacobi-Bellman equation and provide a suitable verification theorem. The proof of this verification theorem is complicated by the fact that the Epstein-Zin aggregator is non-Lipschitz, so standard verification results (e.g., [D. Duffie and L. G. Epstein, Econometrica 60, No. 2, 353–394 (1992; Zbl 0763.90005)]) are not applicable. We provide new explicit solutions to the Bellman equation with Epstein-Zin preferences in an incomplete market for non-unit elasticity of intertemporal substitution (EIS) and apply our verification result to prove that they solve the consumption-investment problem. We also compare our exact solutions to the Campbell-Shiller approximation and assess its accuracy.

Cited in 24 Documents

MSC:

91G10 Portfolio theory
93E20 Optimal stochastic control
90C39 Dynamic programming

Keywords:

consumption-portfolio optimization; recursive utility; stochastic control approach; stochastic volatility; unspanned state process; Campbell-Shiller approximation

Citations:

Zbl 0763.90005
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\textit{H. Kraft} et al., Finance Stoch. 17, No. 1, 161--196 (2013; Zbl 1257.91042)
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