Robust Consumption and Portfolio Policies When Asset Prices Can Jump
Journal of Economic Theory, 2019, 179, 1-56.
73 Pages Posted: 1 Jun 2017 Last revised: 14 Jul 2020
Date Written: September 24, 2018
Abstract
We study the consumption-portfolio allocation problem in continuous time when asset prices follow Levy processes and the investor is concerned about potential model misspecification. We derive optimal consumption and portfolio policies that are robust to uncertainty about the hard-to-estimate
drift rate, jump intensity and jump size parameters. We also provide a semi-closed form formula for the detection-error probability and compare various portfolio holding strategies, including robust and non-robust policies. Our quantitative analysis shows that ignoring uncertainty leads to significant wealth loss for the investor.
Keywords: Optimal consumption and portfolio selection, jumps, Levy processes, robust control, closed form solution
JEL Classification: G10, J75, E20
Suggested Citation: Suggested Citation