Portfolio Optimization under Convex Incentive Schemes
We consider the terminal wealth utility maximization problem from the point of view of a portfolio manager who is paid by an incentive scheme, which is given as a convex function $g$ of the terminal wealth. The manager's own utility function $U$ is assumed to be smooth and strictly concave, however the resulting utility function $U \circ g$ fails to be concave. As a consequence, the problem considered here does not fit into the classical portfolio optimization theory. Using duality theory, we prove wealth-independent existence and uniqueness of the optimal portfolio in general (incomplete) semimartingale markets as long as the unique optimizer of the dual problem has a continuous law. In many cases, this existence and uniqueness result is independent of the incentive scheme and depends only on the structure of the set of equivalent local martingale measures. As examples, we discuss (complete) one-dimensional models as well as (incomplete) lognormal mixture and popular stochastic volatility models. We also provide a detailed analysis of the case where the unique optimizer of the dual problem does not have a continuous law, leading to optimization problems whose solvability by duality methods depends on the initial wealth of the investor.
|Date of creation:||Sep 2011|
|Date of revision:||Oct 2013|
|Publication status:||Published in Finance and Stochastics, 18:4, pp. 873-915 (2014)|
|Contact details of provider:|| Web page: http://arxiv.org/|
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Frey, Rüdiger, 1997. "Derivative Asset Analysis in Models with Level-Dependent and Stochastic Volatility," Discussion Paper Serie B 401, University of Bonn, Germany.
- repec:dau:papers:123456789/1531 is not listed on IDEAS
- B. Bouchard & N. Touzi & A. Zeghal, 2004. "Dual formulation of the utility maximization problem: the case of nonsmooth utility," Papers math/0405290, arXiv.org.
- Merton, Robert C., 1971.
"Optimum consumption and portfolio rules in a continuous-time model,"
Journal of Economic Theory,
Elsevier, vol. 3(4), pages 373-413, December.
- R. C. Merton, 1970. "Optimum Consumption and Portfolio Rules in a Continuous-time Model," Working papers 58, Massachusetts Institute of Technology (MIT), Department of Economics.
- Jennifer N. Carpenter, 2000. "Does Option Compensation Increase Managerial Risk Appetite?," Journal of Finance, American Finance Association, vol. 55(5), pages 2311-2331, October.
- Peter Carr & Jian Sun, 2007. "A new approach for option pricing under stochastic volatility," Review of Derivatives Research, Springer, vol. 10(2), pages 87-150, May.
- Stavros Panageas & Mark M. Westerfield, 2009. "High-Water Marks: High Risk Appetites? Convex Compensation, Long Horizons, and Portfolio Choice," Journal of Finance, American Finance Association, vol. 64(1), pages 1-36, 02.
- Stephen A. Ross, 2004. "Compensation, Incentives, and the Duality of Risk Aversion and Riskiness," Journal of Finance, American Finance Association, vol. 59(1), pages 207-225, 02. Full references (including those not matched with items on IDEAS)
When requesting a correction, please mention this item's handle: RePEc:arx:papers:1109.2945. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (arXiv administrators)
If references are entirely missing, you can add them using this form.