Wealth Effect on Portfolio Allocation in Incomplete Markets
Portfolio Management
2021-08-27 v3
Abstract
We develop a novel five-component decomposition of optimal dynamic portfolio choice, which reveals the simultaneous impacts from market incompleteness and wealth-dependent utilities. Under the HARA utility and a nonrandom interest rate, we can explicitly solve for the optimal policy as a combination of a bond holding scheme and the corresponding simpler CRRA strategy. Under a stochastic volatility model estimated on US equity data, we use closed-form solution to demonstrate the sophisticated impacts from the wealth-dependent utilities, including cycle-dependence and hysteresis effect in optimal portfolio allocation, as well as a risk-return trade-off in investment performance.
Keywords
Cite
@article{arxiv.2004.10096,
title = {Wealth Effect on Portfolio Allocation in Incomplete Markets},
author = {Chenxu Li and Olivier Scaillet and Yiwen Shen},
journal= {arXiv preprint arXiv:2004.10096},
year = {2021}
}