A computational scheme for the optimal strategy in an incomplete market

We examine the optimal portfolio selection problem of a single agent who receives an unhedgeable endowment. The agent wishes to optimize his/her log-utility derived from his/her terminal wealth. We do not solve this problem analytically but construct a recursive computational algorithm which approxi...

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Bibliographic Details
Published in:Journal of economic dynamics & control Vol. 31; no. 11; pp. 3591 - 3613
Main Authors: Keppo, Jussi, Meng, Xu, Sullivan, Michael G.
Format: Journal Article
Language:English
Published: Amsterdam Elsevier B.V 01.11.2007
North-Holland Publ. Co
Elsevier
Elsevier Sequoia S.A
Series:Journal of Economic Dynamics and Control
Subjects:
Algorithms
Computational methods
Endowment
Endowment uncertainty
Hedging
Incomplete markets
Intelligence
Investment decision
Market analysis
Numerical methods
Optimization algorithms
Portfolio management
Portfolio selection
Portfolios
Recursion
Studies
Utility maximization
Utility measurement
Wealth
D52
Utility maximization
G11
Incomplete markets
Endowment uncertainty
Numerical methods
ISSN:0165-1889, 1879-1743
Online Access:Get full text
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Summary:We examine the optimal portfolio selection problem of a single agent who receives an unhedgeable endowment. The agent wishes to optimize his/her log-utility derived from his/her terminal wealth. We do not solve this problem analytically but construct a recursive computational algorithm which approximates the optimal one. We present an ‘intelligent’ initial portfolio which requires, numerically, about 25 % fewer corrective steps in the algorithm than a random initial portfolio, and outperforms the portfolio which ignores the unhedgeable risk of the endowment.
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ISSN:0165-1889
1879-1743
DOI:10.1016/j.jedc.2006.12.006