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Optimal lifetime consumption-portfolio strategies under trading constraints and generalized recursive preferences

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  • Schroder, Mark
  • Skiadas, Costis
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    Abstract

    We consider the lifetime consumption-portfolio problem in a competitive securities market with essentially arbitrary continuous price dynamics, and convex trading constraints (e.g., incomplete markets and short-sale constraints). Abstract first-order conditions of optimality are derived, based on a preference-independent notion of constrained state pricing. For homothetic generalized recursive utility, we derive closed-form solutions for the optimal consumption and trading strategy in terms of the solution to a single constrained BSDE. Incomplete market solutions are related to complete markets solutions with modified risk aversion towards non-marketed risk. Methodologically, we develop the utility gradient approach, but for the homothetic case we also verify the solution using the dynamic programming approach, without having to assume a Markovian structure. Finally, we present a class of parametric examples in which the BSDE characterizing the solution reduces to a system of Riccati equations.

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    Bibliographic Info

    Article provided by Elsevier in its journal Stochastic Processes and their Applications.

    Volume (Year): 108 (2003)
    Issue (Month): 2 (December)
    Pages: 155-202

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    Handle: RePEc:eee:spapps:v:108:y:2003:i:2:p:155-202

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    Citations

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    Cited by:
    1. Sbuelz, Alessandro & Trojani, Fabio, 2008. "Asset prices with locally constrained-entropy recursive multiple-priors utility," Journal of Economic Dynamics and Control, Elsevier, vol. 32(11), pages 3695-3717, November.
    2. Maenhout, Pascal J., 2006. "Robust portfolio rules and detection-error probabilities for a mean-reverting risk premium," Journal of Economic Theory, Elsevier, vol. 128(1), pages 136-163, May.
    3. Liu, Hening, 2011. "Dynamic portfolio choice under ambiguity and regime switching mean returns," Journal of Economic Dynamics and Control, Elsevier, vol. 35(4), pages 623-640, April.
    4. Luca Benzoni & Pierre Collin-Dufresne & Robert S. Goldstein, 2007. "Portfolio choice over the life-cycle when the stock and labor markets are cointegrated," Working Paper Series WP-07-11, Federal Reserve Bank of Chicago.
    5. Wang, Neng, 2007. "An equilibrium model of wealth distribution," Journal of Monetary Economics, Elsevier, vol. 54(7), pages 1882-1904, October.
    6. Martin B. Haugh & Leonid Kogan & Jiang Wang, 2003. "Evaluating Portfolio Policies: A Duality Approach," NBER Working Papers 9861, National Bureau of Economic Research, Inc.
    7. Luca Benzoni & Pierre Collin-Dufresne & Robert S. Goldstein, 2005. "Portfolio Choice over the Life-Cycle in the Presence of 'Trickle Down' Labor Income," NBER Working Papers 11247, National Bureau of Economic Research, Inc.
    8. Bhamra, Harjoat S. & Uppal, Raman, 2005. "The Role of Risk Aversion and Intertemporal Substitution in Dynamic Consumption-Portfolio Choicewith Recursive Utility," CEPR Discussion Papers 5020, C.E.P.R. Discussion Papers.
    9. Benzoni, Luca & Collin-Dufresne, Pierre & Goldstein, Robert S., 2011. "Explaining asset pricing puzzles associated with the 1987 market crash," Journal of Financial Economics, Elsevier, vol. 101(3), pages 552-573, September.
    10. Holger Kraft & Frank Seifried & Mogens Steffensen, 2013. "Consumption-portfolio optimization with recursive utility in incomplete markets," Finance and Stochastics, Springer, vol. 17(1), pages 161-196, January.
    11. Hening Liu, 2010. "Robust consumption and portfolio choice for time varying investment opportunities," Annals of Finance, Springer, vol. 6(4), pages 435-454, October.

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