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On the Exact Solution of the Multi-Period Portfolio Choice Problem for an Exponential Utility under Return Predictability

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  • Taras Bodnar
  • Nestor Parolya
  • Wolfgang Schmid

Abstract

In this paper we derive the exact solution of the multi-period portfolio choice problem for an exponential utility function under return predictability. It is assumed that the asset returns depend on predictable variables and that the joint random process of the asset returns and the predictable variables follow a vector autoregressive process. We prove that the optimal portfolio weights depend on the covariance matrices of the next two periods and the conditional mean vector of the next period. The case without predictable variables and the case of independent asset returns are partial cases of our solution. Furthermore, we provide an empirical study where the cumulative empirical distribution function of the investor's wealth is calculated using the exact solution. It is compared with the investment strategy obtained under the additional assumption that the asset returns are independently distributed.

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  • Taras Bodnar & Nestor Parolya & Wolfgang Schmid, 2012. "On the Exact Solution of the Multi-Period Portfolio Choice Problem for an Exponential Utility under Return Predictability," Papers 1207.1037, arXiv.org.
  • Handle: RePEc:arx:papers:1207.1037
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    References listed on IDEAS

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    Cited by:

    1. Bodnar, Taras & Mazur, Stepan & Okhrin, Yarema, 2017. "Bayesian estimation of the global minimum variance portfolio," European Journal of Operational Research, Elsevier, vol. 256(1), pages 292-307.
    2. Bodnar, Taras & Parolya, Nestor & Schmid, Wolfgang, 2018. "Estimation of the global minimum variance portfolio in high dimensions," European Journal of Operational Research, Elsevier, vol. 266(1), pages 371-390.
    3. Zhou, Zhongbao & Xiao, Helu & Yin, Jialing & Zeng, Ximei & Lin, Ling, 2016. "Pre-commitment vs. time-consistent strategies for the generalized multi-period portfolio optimization with stochastic cash flows," Insurance: Mathematics and Economics, Elsevier, vol. 68(C), pages 187-202.
    4. Lu, Jin-Ray & Hwang, Chih-Chiang & Liu, Min-Luan & Lin, Chien-Yi, 2016. "An incentive problem of risk balancing in portfolio choices," The Quarterly Review of Economics and Finance, Elsevier, vol. 61(C), pages 192-200.

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