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Portfolio Selection in Stochastic Environments

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  • Jun Liu

Abstract

In this article, I explicitly solve dynamic portfolio choice problems, up to the solution of an ordinary differential equation (ODE), when the asset returns are quadratic and the agent has a constant relative risk aversion (CRRA) coefficient. My solution includes as special cases many existing explicit solutions of dynamic portfolio choice problems. I also present three applications that are not in the literature. Application 1 is the bond portfolio selection problem when bond returns are described by "quadratic term structure models." Application 2 is the stock portfolio selection problem when stock return volatility is stochastic as in Heston model. Application 3 is a bond and stock portfolio selection problem when the interest rate is stochastic and stock returns display stochastic volatility. (JEL G11) Copyright 2007, Oxford University Press.

Suggested Citation

  • Jun Liu, 2007. "Portfolio Selection in Stochastic Environments," The Review of Financial Studies, Society for Financial Studies, vol. 20(1), pages 1-39, January.
    • Handle: RePEc:oup:rfinst:v:20:y:2007:i:1:p:1-39
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    File URL: http://hdl.handle.net/10.1093/rfs/hhl001
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    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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