Optimal investment and consumption when regime transitions cause price shocks
This paper concerns optimal investment and consumption with CRRA utility when there is event risk. Events are modeled by transitions in a finite state Markov chain, but unlike traditional regime switching models, transitions not only change the instantaneous return statistics but are accompanied by...
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| Veröffentlicht in: | Insurance, mathematics & economics mathematics & economics, 2012-11, Vol.51 (3), p.551-566 |
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| container_title | Insurance, mathematics & economics |
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| creator | Lim, Andrew E.B. Watewai, Thaisiri |
| description | This paper concerns optimal investment and consumption with CRRA utility when there is event risk. Events are modeled by transitions in a finite state Markov chain, but unlike traditional regime switching models, transitions not only change the instantaneous return statistics but are accompanied by jumps in the price at the instant of transition. Optimal investment and consumption policies are characterized using stochastic control methods and computed by solving a system of ordinary differential equations and a convex optimization problem. We show that optimal policies are significantly different from those of traditional regime switching or jump-diffusion problems and that the cost of ignoring transition price shocks can be substantial.
► We solve investment and consumption problems when there is event risk. ► Unlike traditional regime switching, prices jump at the instant of transition. ► Optimal solutions significantly differ from those of traditional regime switching. ► The cost of ignoring transition price shocks can be substantial. |
| doi_str_mv | 10.1016/j.insmatheco.2012.07.011 |
| format | Article |
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► We solve investment and consumption problems when there is event risk. ► Unlike traditional regime switching, prices jump at the instant of transition. ► Optimal solutions significantly differ from those of traditional regime switching. ► The cost of ignoring transition price shocks can be substantial.</description><identifier>ISSN: 0167-6687</identifier><identifier>EISSN: 1873-5959</identifier><identifier>DOI: 10.1016/j.insmatheco.2012.07.011</identifier><identifier>CODEN: IMECDX</identifier><language>eng</language><publisher>Amsterdam: Elsevier B.V</publisher><subject>Consumption policies ; Convex analysis ; Defaultable bonds ; Economic shock ; Event risk ; Investment ; Jump processes ; Markov analysis ; Markovian processes ; Mathematical models ; Optimal investment and consumption ; Ordinary differential equations ; Price theory ; Regime switching ; Risk aversion ; Stochastic control ; Stochastic control theory ; Stochastic processes ; Studies ; Utility theory</subject><ispartof>Insurance, mathematics & economics, 2012-11, Vol.51 (3), p.551-566</ispartof><rights>2012 Elsevier B.V.</rights><rights>Copyright Elsevier Sequoia S.A. Nov 2012</rights><lds50>peer_reviewed</lds50><woscitedreferencessubscribed>false</woscitedreferencessubscribed><citedby>FETCH-LOGICAL-c443t-f0a92554a201db7f0d2acd364d4593973c8b16dc258f8d395a0b1633a337c40c3</citedby><cites>FETCH-LOGICAL-c443t-f0a92554a201db7f0d2acd364d4593973c8b16dc258f8d395a0b1633a337c40c3</cites></display><links><openurl>$$Topenurl_article</openurl><openurlfulltext>$$Topenurlfull_article</openurlfulltext><thumbnail>$$Tsyndetics_thumb_exl</thumbnail><linktohtml>$$Uhttps://www.sciencedirect.com/science/article/pii/S016766871200090X$$EHTML$$P50$$Gelsevier$$H</linktohtml><link.rule.ids>314,776,780,3537,27901,27902,65306</link.rule.ids></links><search><creatorcontrib>Lim, Andrew E.B.</creatorcontrib><creatorcontrib>Watewai, Thaisiri</creatorcontrib><title>Optimal investment and consumption when regime transitions cause price shocks</title><title>Insurance, mathematics & economics</title><description>This paper concerns optimal investment and consumption with CRRA utility when there is event risk. Events are modeled by transitions in a finite state Markov chain, but unlike traditional regime switching models, transitions not only change the instantaneous return statistics but are accompanied by jumps in the price at the instant of transition. Optimal investment and consumption policies are characterized using stochastic control methods and computed by solving a system of ordinary differential equations and a convex optimization problem. We show that optimal policies are significantly different from those of traditional regime switching or jump-diffusion problems and that the cost of ignoring transition price shocks can be substantial.
► We solve investment and consumption problems when there is event risk. ► Unlike traditional regime switching, prices jump at the instant of transition. ► Optimal solutions significantly differ from those of traditional regime switching. ► The cost of ignoring transition price shocks can be substantial.</description><subject>Consumption policies</subject><subject>Convex analysis</subject><subject>Defaultable bonds</subject><subject>Economic shock</subject><subject>Event risk</subject><subject>Investment</subject><subject>Jump processes</subject><subject>Markov analysis</subject><subject>Markovian processes</subject><subject>Mathematical models</subject><subject>Optimal investment and consumption</subject><subject>Ordinary differential equations</subject><subject>Price theory</subject><subject>Regime switching</subject><subject>Risk aversion</subject><subject>Stochastic control</subject><subject>Stochastic control theory</subject><subject>Stochastic processes</subject><subject>Studies</subject><subject>Utility theory</subject><issn>0167-6687</issn><issn>1873-5959</issn><fulltext>true</fulltext><rsrctype>article</rsrctype><creationdate>2012</creationdate><recordtype>article</recordtype><recordid>eNqFkE1LxDAQhoMouH78h4AXL62Tpm2ao4pfsOJFzyGbTN2s22RNWsV_b5YVBC-ehpl5ZnjflxDKoGTA2otV6Xwa9LhEE8oKWFWCKIGxPTJjneBFIxu5T2YZFUXbduKQHKW0AgAmWzEjj0-b0Q16TZ3_wDQO6EeqvaUm-DQNeRc8_VyipxFf3YB0jNontx0navSUkG6iM0jTMpi3dEIOer1OePpTj8nL7c3z9X0xf7p7uL6cF6au-Vj0oGXVNLXOeu1C9GArbSxva1s3kkvBTbdgrTVV0_Wd5bLRkHvONefC1GD4MTnf_d3E8D5l3WpwyeB6rT2GKSlWcWgk4x3L6NkfdBWm6LM6xVgNlZScQaa6HWViSClir7KtQccvxUBtc1Yr9Zuz2uasQKiccz692p1iNvzhMKpkHHqD1kU0o7LB_f_kG1k7i8M</recordid><startdate>20121101</startdate><enddate>20121101</enddate><creator>Lim, Andrew E.B.</creator><creator>Watewai, Thaisiri</creator><general>Elsevier B.V</general><general>Elsevier Sequoia S.A</general><scope>AAYXX</scope><scope>CITATION</scope><scope>8BJ</scope><scope>FQK</scope><scope>JBE</scope><scope>JQ2</scope></search><sort><creationdate>20121101</creationdate><title>Optimal investment and consumption when regime transitions cause price shocks</title><author>Lim, Andrew E.B. ; Watewai, Thaisiri</author></sort><facets><frbrtype>5</frbrtype><frbrgroupid>cdi_FETCH-LOGICAL-c443t-f0a92554a201db7f0d2acd364d4593973c8b16dc258f8d395a0b1633a337c40c3</frbrgroupid><rsrctype>articles</rsrctype><prefilter>articles</prefilter><language>eng</language><creationdate>2012</creationdate><topic>Consumption policies</topic><topic>Convex analysis</topic><topic>Defaultable bonds</topic><topic>Economic shock</topic><topic>Event risk</topic><topic>Investment</topic><topic>Jump processes</topic><topic>Markov analysis</topic><topic>Markovian processes</topic><topic>Mathematical models</topic><topic>Optimal investment and consumption</topic><topic>Ordinary differential equations</topic><topic>Price theory</topic><topic>Regime switching</topic><topic>Risk aversion</topic><topic>Stochastic control</topic><topic>Stochastic control theory</topic><topic>Stochastic processes</topic><topic>Studies</topic><topic>Utility theory</topic><toplevel>peer_reviewed</toplevel><toplevel>online_resources</toplevel><creatorcontrib>Lim, Andrew E.B.</creatorcontrib><creatorcontrib>Watewai, Thaisiri</creatorcontrib><collection>CrossRef</collection><collection>International Bibliography of the Social Sciences (IBSS)</collection><collection>International Bibliography of the Social Sciences</collection><collection>International Bibliography of the Social Sciences</collection><collection>ProQuest Computer Science Collection</collection><jtitle>Insurance, mathematics & economics</jtitle></facets><delivery><delcategory>Remote Search Resource</delcategory><fulltext>fulltext</fulltext></delivery><addata><au>Lim, Andrew E.B.</au><au>Watewai, Thaisiri</au><format>journal</format><genre>article</genre><ristype>JOUR</ristype><atitle>Optimal investment and consumption when regime transitions cause price shocks</atitle><jtitle>Insurance, mathematics & economics</jtitle><date>2012-11-01</date><risdate>2012</risdate><volume>51</volume><issue>3</issue><spage>551</spage><epage>566</epage><pages>551-566</pages><issn>0167-6687</issn><eissn>1873-5959</eissn><coden>IMECDX</coden><abstract>This paper concerns optimal investment and consumption with CRRA utility when there is event risk. Events are modeled by transitions in a finite state Markov chain, but unlike traditional regime switching models, transitions not only change the instantaneous return statistics but are accompanied by jumps in the price at the instant of transition. Optimal investment and consumption policies are characterized using stochastic control methods and computed by solving a system of ordinary differential equations and a convex optimization problem. We show that optimal policies are significantly different from those of traditional regime switching or jump-diffusion problems and that the cost of ignoring transition price shocks can be substantial.
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| ispartof | Insurance, mathematics & economics, 2012-11, Vol.51 (3), p.551-566 |
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| source | Elsevier ScienceDirect Journals |
| subjects | Consumption policies Convex analysis Defaultable bonds Economic shock Event risk Investment Jump processes Markov analysis Markovian processes Mathematical models Optimal investment and consumption Ordinary differential equations Price theory Regime switching Risk aversion Stochastic control Stochastic control theory Stochastic processes Studies Utility theory |
| title | Optimal investment and consumption when regime transitions cause price shocks |
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