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Consuming durable goods when stock markets jump: a strategic asset allocation approach

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  • João Amaro de Matos

    (Nova School of Business & Economics)

  • Nuno Silva

    (Faculty of Economics University of Coimbra and GEMF)

Abstract

Agents derive their utilities from consumption over time. In this paper we consider an agent that invests in the financial market and in consumption goods. The agent has an infinite time horizon and a utility that depends on consumption at each point in time, consuming both a durable good and a perishable good. There are costs for transacting the durable good. We show that an agent who does not consider the impact of jumps in the return process of risky assets will make suboptimal decisions, not only regarding the fraction of wealth invested in the stock market, but also with respect to the timing for trading on the durable good.

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Bibliographic Info

Paper provided by GEMF - Faculdade de Economia, Universidade de Coimbra in its series GEMF Working Papers with number 2012-01.

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Length: 36 pages
Date of creation: Dec 2011
Date of revision:
Handle: RePEc:gmf:wpaper:2012-01

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Keywords: Optimal asset allocation; durable consumption good; transaction costs.;

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References

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  1. Cuoco, Domenico & Liu, Hong, 2000. "Optimal consumption of a divisible durable good," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 24(4), pages 561-613, April.
  2. Ait-Sahalia, Yacine & Wang, Yubo & Yared, Francis, 2001. "Do option markets correctly price the probabilities of movement of the underlying asset?," Journal of Econometrics, Elsevier, Elsevier, vol. 102(1), pages 67-110, May.
  3. Peter Carr & Liuren Wu, 2003. "What Type of Process Underlies Options? A Simple Robust Test," Journal of Finance, American Finance Association, American Finance Association, vol. 58(6), pages 2581-2610, December.
  4. Jarrow, Robert A & Rosenfeld, Eric R, 1984. "Jump Risks and the Intertemporal Capital Asset Pricing Model," The Journal of Business, University of Chicago Press, University of Chicago Press, vol. 57(3), pages 337-51, July.
  5. Grossman, Sanford J & Laroque, Guy, 1990. "Asset Pricing and Optimal Portfolio Choice in the Presence of Illiquid Durable Consumption Goods," Econometrica, Econometric Society, Econometric Society, vol. 58(1), pages 25-51, January.
  6. Jackwerth, Jens Carsten & Rubinstein, Mark, 1996. " Recovering Probability Distributions from Option Prices," Journal of Finance, American Finance Association, American Finance Association, vol. 51(5), pages 1611-32, December.
  7. Chellathurai, Thamayanthi & Draviam, Thangaraj, 2007. "Dynamic portfolio selection with fixed and/or proportional transaction costs using non-singular stochastic optimal control theory," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 31(7), pages 2168-2195, July.
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  10. Pan, Jun, 2002. "The jump-risk premia implicit in options: evidence from an integrated time-series study," Journal of Financial Economics, Elsevier, Elsevier, vol. 63(1), pages 3-50, January.
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  13. Valeri Zakamouline, 2005. "A unified approach to portfolio optimization with linear transaction costs," Computational Statistics, Springer, Springer, vol. 62(2), pages 319-343, November.
  14. Damgaard, Anders & Fuglsbjerg, Brian & Munk, Claus, 2003. "Optimal consumption and investment strategies with a perishable and an indivisible durable consumption good," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 28(2), pages 209-253, November.
  15. Monoyios, Michael, 2004. "Option pricing with transaction costs using a Markov chain approximation," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 28(5), pages 889-913, February.
  16. Suzanne S. Lee & Per A. Mykland, 2008. "Jumps in Financial Markets: A New Nonparametric Test and Jump Dynamics," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 21(6), pages 2535-2563, November.
  17. Hong Liu, 2004. "Optimal Consumption and Investment with Transaction Costs and Multiple Risky Assets," Journal of Finance, American Finance Association, American Finance Association, vol. 59(1), pages 289-338, 02.
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