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The relaxed investor and parameter uncertainty

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  • L.C.G. Rogers

    ()
    (University of Bath, Department of Mathematical Sciences, Bath BA2 7AY, UK Manuscript)

Abstract

We firstly consider an investor faced with the classical Merton problem of optimal investment in a log-Brownian asset and a fixed-interest bond, but constrained only to change portfolio (and, if relevant, consumption) choices at times which are a multiple of h. We show that the cost of this constraint can be well described by a power series expansion in h, the first few terms of which we determine explicitly. Typically, this cost is not too large. We then compare this with the cost of parameter uncertainty, as modelled by supposing that the rate of return on the share has a prior Gaussian distribution. We find that the effect of parameter uncertainty is typically bigger than the effects of infrequent policy review.

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Bibliographic Info

Article provided by Springer in its journal Finance and Stochastics.

Volume (Year): 5 (2001)
Issue (Month): 2 ()
Pages: 131-154

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Handle: RePEc:spr:finsto:v:5:y:2001:i:2:p:131-154

Note: received: November 1999; final version received: June 2000
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Related research

Keywords: Merton consumption problem; Merton investment problem; time lag; parameter uncertainty;

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