a computational scheme for the optimal strategy in an incomplete market abstract 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

understanding dynamic mean variance asset allocation abstract we provide a new portfolio decomposition formula that sheds light on the economics of portfolio choice for investors following the mean variance mv criterion we show that the number of components of a dynamic portfolio strategy can be reduced to two the first is preference free and hedges the risk of a discount bond maturing at the investor s horizon while the second hedges the time variation in pseudo relative risk tolerance both components entail strong horizon effects in the dynamic asset allocation as a result of time varying risk tolerance and investment opportunity sets we also provide closed form solutions for the optimal portfolio strategy in the presence of market return predictability the model parameters are estimated over the period 1963 to 2012 for the u s market we show that i intertemporal hedging can be very large ii the mv criterion hugely understates the true extent of risk aversion for high values of the risk aversion parameter and the more so the shorter the investment horizon and iii the efficient frontiers seem problematic for investment horizons shorter than one year but satisfactory for large horizons overall adopting the mv model leads to acceptable results for medium and long term investors endowed with medium or high risk tolerance but to very problematic ones otherwise

hedge fund seeding via fees for seed swaps under idiosyncratic risk we develop a dynamic valuation model of the hedge fund seeding business by solving the consumption and portfolio choice problem for a risk averse manager who launches a hedge fund through a seeding vehicle this vehicle i e fees for seed swap specifies that a strategic partner seeder provides a critical amount of capital in exchange for participation in the funds revenue our results indicate that the new swap not only solves the serious problem of widespread financing constraints for new and early stage funds esfs managers but can be highly beneficial to both the manager and the seeder if structured properly

medium term power planning with bilateral contracts this paper addresses the optimal management of hydropower resources on medium term the objective is to maximize the expected revenue of a producer and the decision variables are generation and forward contracts in each period for each scenario stochastic linear and nonlinear programming has been used as a framework for modeling and solution results are exposited for a norwegian power producer participating in nord pool the nordic power exchange

ambiguous volatility and asset pricing in continuous time we formulate a model of utility for a continuous time framework that captures aversion to ambiguity about both volatility and drift corresponding extensions of some basic results in asset pricing theory are presented first we derive arbitrage free pricing rules based on hedging arguments because ambiguous volatility implies market incompleteness hedging arguments determine prices only up to intervals in order to obtain sharper predictions we apply the model of utility to a representative agent endowment economy and study equilibrium asset returns a version of the consumption capital asset pricing model is derived and the effects of ambiguous volatility are described the author 2013 published by oxford university press on behalf of the society for financial studies all rights reserved for permissions please e mail journals permissions oup com oxford university press

preference heterogeneity and asset prices an exact solution abstract we introduce a general equilibrium model of a multi agent pure exchange economy and find a set of conditions that enable us to obtain explicit closed form solutions to the equilibrium interest rate stock price risk premium and stock market volatility when investors have heterogenous risk aversions because the market is dynamically complete full risk sharing obtains and a representative agent can be constructed though the risk aversion of this agent fluctuates over time with the state of the economy as the relative wealth distribution of the individual investors changes we show that preference heterogeneity can cause asset prices to be significantly more volatile than the underlying dividends and that it can lead to leverage like effects in volatility in the sense that volatility increases after stock market declines

an asset allocation puzzle comment should the proportion of risky assets in the risky part of an investor s portfolio depend on the investor s risk aversion according to basic financial theory in particular the mutual fund separation theorem with a riskless asset the answer is no the theorem states that rational investors should divide their assets between a riskless asset and a risky mutual fund the composition of which is the same for all investors risk aversion affects only the allocation between the riskless asset and the fund however niko canner et al 1997 cmw hereafter observed that popular investment advice does not conform to this theory they reported the stocks bonds and cash allocations recommended by four advisors for conservative moderate and aggressive investors as shown in table 1 which is reproduced from cmw the advisors recommend a bond stock ratio that varies directly with risk aversion for example fidelity recommends a bond stock ratio of 1 50 for a conservative more riskaverse investor a ratio of 1 00 for a moderate less risk averse investor and a ratio of 0 46 for an aggressive still less risk averse investor the inconsistency between such advice and the separation theorem is called an asset allocation puzzle by cmw they attempted to solve the puzzle by relaxing key assumptions in the theory but finally reached a negative conclusion although we cannot rule out the possibility that popular advice is consistent with some model of rational behavior we have so far been unable to find such a model p 181 however they suggested that consideration of intertemporal trading might help resolve the puzzle in the present paper we provide theoretical support for the popular advice the two key insights are that the investor s horizon may exceed the maturity of the cash asset and that the investor rebalances the portfolio as time passes if the investor s horizon exceeds the maturity of cash which might be a money market security with maturity of one to six months then cash is not the riskless asset as is commonly assumed in the basic theory in a theory allowing portfolio rebalancing as opposed to a buy and hold framework it is not unreasonable to assume that the investor can synthesize a riskless asset a zero coupon bond maturing at the horizon using a bond fund and cash then bonds will be both in the synthetic riskless asset and in the risky mutual fund and we show that in this case the theoretical bond stock ratio varies directly with risk aversion for any hyperbolic absolute risk aversion hara investor as an example of the type of results that a specific model can produce we provide a continuous time model with closed form solutions which produces theoretical bond stock ratios similar to the popular advice the present paper is organized as follows in the next section we analyze the popular advice in terms of the theory of mutual fund separation of david cass and joseph e stiglitz 1970 we show that this theory is relevant both in static and dynamic frameworks and use it to analyze the popular advice in complete and incomplete markets in section ii we analyze the popular advice in the context of robert c merton s 1971 continuous time statement of mutualfund separation and present an illustrative model in which a crra investor makes continuous time portfolio decisions under interest rate and stock price uncertainty in section iii numerical results are compared with the popular advice section iv is a conclusion bajeux besnainou department of finance school of business and public management george washington university 2023 g street nw washington dc 20052 jordan national economic research associates 1255 23rd street nw washington dc 20037 portait cnam and essec finance chair cnam 2 rue conte paris france this research was supported by a grant from the institute for quantitative investment research we thank two anonymous referees for their comments 1 hara functions include quadratic utility which is one way of justifying mean variance preferences and constant relative risk aversion crra utility both quadratic and crra utility were considered in the cmw analysis

a note on merton s optimum consumption and portfolio rules in a continuous time model in the paper optimum consumption and portfolio rules in a continuous time model by r c merton j econ theory 3 1971 373 413 solutions obtained in cases when marginal utility at zero consumption is finite are not feasible while they do satisfy the hamilton jacobi bellman equations they do not represent appropriate value functions because the boundary behavior near zero wealth is not satisfactorily dealt with in this note we specify the boundary behavior and characterize optimal solutions journal of economic literature classification numbers 022 213

risk aversion in a dynamic asset allocation experiment we conduct a controlled laboratory experiment in the spirit of merton 1971 in which subjects dynamically choose their portfolio allocation between a risk free and risky asset using the optimal allocation of an investor with hyperbolic absolute risk aversion hara utility we fit the experimental choices to characterize the risk profile of our participants despite substantial heterogeneity decreasing absolute risk aversion and increasing relative risk aversion are the predominant types we also find some evidence of increased risk taking after a gain finally the session level risk attitudes show a different profile than the individual descriptions of risk attitudes

optimal portfolio policies with borrowing and shortsale constraints abstract we characterize optimal intertemporal portfolio policies for investors with crra utility facing either a borrowing constraint or shortsale restrictions or both the optimal constrained portfolios are identified as optimal unconstrained portfolios for a higher riskless rate or for a subset of the risky assets or for a combination of the two settings our characterization is based on duality results in cvitanic and karatzas 1992 annals of applied probability 2 767 818 for optimal portfolio investment when portfolio values are more generally constrained to a closed convex nonempty subset of r n

an exploration of the forward premium puzzle in currency markets a standard empirical finding is that expected changes in exchange rates and interest rate differentials across countries are negatively related implying that uncovered interest rate parity is violated in the data this article provides new empirical evidence that suggests that violations of uncovered interest rate parity and its economic implications depend on the sign of the interest rate differentially a framework related to term structure models is developed to account for the puzzling relationship between expected changes in exchange rates and interest rate differentials estimation results suggest that a particular term structure model can account for the puzzling empirical evidence article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

investor heterogeneity asset pricing and volatility dynamics abstract we provide an explicit characterization of the equilibrium when investors have heterogeneous risk preferences given market completeness investors can achieve full risk sharing thus a representative agent can be constructed though this agent s risk aversion changes over time as the relative wealths of the individual investors change we show that volatility depends on the covariance of aggregate risk aversion and stock returns we find that heterogeneity increases volatility produces volatility clustering arch effects and leverage like effects option prices exhibit implied volatility skews there is predictability and we assess the magnitude of investors hedging demands and trading volume further diversity is beneficial to all agents and entails welfare gains that can be substantial

housing markets consumption and financial liberalisation in the major economies abstract this paper analyses the implications of relaxing credit restrictions in housing finance markets a theoretical model of the interaction of financial and housing markets and forward looking agents is developed the effects of financial liberalisation in the model are analysed and evidence from the u s a and u k on the impact of easing credit restrictions is presented estimates are also made of the degree to which credit restrictions may bind on households in those countries where the range of mortgage products on offer is still more limited than in the u k and u s a simulations are undertaken to gauge the effect on consumption saving and bequests of wealth of possible future convergence in national systems of housing finance

dynamic portfolio choice with parameter uncertainty and the economic value of analysts recommendations we derive a closed form solution for the optimal portfolio of a non myopic utility maximizer who has incomplete information about the alphas or abnormal returns of risky securities we show that the hedging component induced by learning about the expected return can be a substantial part of the demand using our methodology we perform an ex ante empirical exercise which shows that the utility gains resulting from optimal allocation are substantial in general especially for long horizons and an ex post empirical exercise which shows that analysts recommendations are not very useful

testing benefits transfer of forest recreation values over a twenty year time horizon we conduct a functional benefit transfer over 20 years of total willingness to pay based on carborne forest recreation in 52 forests using a mixed logit specification of a random utility model and geographic information systems to allow heterogeneous preferences across the population and for heterogeneity over space results show that preferences for some forest attributes such as species diversity and age as well as transport mode have changed significantly over the period updating the transfer model with present total demand for recreation improves the error margins by an average of 282 average errors of the best transfer model remain 25

estimating the cost of leisure time for recreation demand models abstract in this paper we propose a method of determining the opportunity cost of leisure time with an empirical recreation demand application typically the opportunity cost of leisure time is assumed to be some fraction of the wage rate this practice has limitations first it assumes that individuals can trade time for money at their wage second it offers no guidance about how to value the time of an individual who is not in the labor force this paper proposes a method of determining this cost that does not suffer from these drawbacks an empirical example is provided which demonstrates the proposed approach and contrasts it with commonly applied approaches

optimal portfolio management with american capital guarantee abstract the aim of the paper is to investigate finite horizon portfolio strategies which maximize a utility criterion when a constraint is imposed on a terminal date european guarantee or on every intermediate date american guarantee we prove the optimality of the option based portfolio insurance method for both european and american cases when an expected crra utility function is maximized the american obpi is fully described in a black scholes environment as well as in the more general case of complete markets using the gittins index techniques developed by el karoui and karatzas 1995 optimality results are extended to general utility functions

aggregate consumption of non durables and services and the components of wealth some evidence for the united kingdom the growth of spending on consumer goods in the united kingdom in recent years has been a severe test of previously well established consumption functions this paper assesses the performance of a dominant standard consumption function which relies on income and net liquid assets it turns out that this has not been able to track the growth in consumer spending however developments of this consumption function which find a role for the components of personal sector wealth perform rather well with satisfactory diagnostic statistics and an estimated equation standard error of around 0 4

basel s value at risk capital requirement regulation an efficiency analysis abstract we analyze the optimal portfolio policies of expected utility maximizing agents under var capital requirement var cr regulation in comparison to the optimal policy under exogenously imposed var limit var l and limited expected loss lel regulations with var cr regulation the agent strategy consists of simultaneous decisions on both the portfolio var and on the implied amount of required eligible capital as a result the performance of var cr regulation depends on its design the parameter n and the agent preferences we show that an optimal var cr regulation allows the regulator on the one hand to completely eliminate the exposure to the largest losses which may jeopardize the existence of the institution and on the other hand to restrain the portfolio exposure to all other losses these results rationalize the current basel regulations however the analysis shows also that there is an optimal level of required eligible capital from the regulator standpoint counter intuitively any requirement above this optimal level is inefficient as it leads to a smaller amount of actually maintained eligible capital and thereby to a larger exposure to the most adverse states of the world unfortunately the current basel s range of required levels n 3 4 is within this inefficient range moreover with an inefficient regulation the agent might employ an inefficient reporting and disclosure procedure

who should buy long term bonds according to conventional wisdom long term bonds are appropriate for conservative long term investors this paper develops a model of optimal consumption and portfolio choice for infinite lived investors with recursive utility who face stochastic interest rates solves the model using an approximate analytical method and evaluates conventional wisdom as risk aversion increases the myopic component of risky asset demand disappears but the intertemporal hedging component does not conservative investors hold assets to hedge the risk that real interest rates will decline long term inflation indexed bonds are most suitable for this purpose but nominal bonds may also be used if inflation risk is low

welfare losses due to livestock grazing on public lands a count data systemwide treatment backcountry hikers willingness to pay for removing grazing from trails in the hoover wilderness is analyzed using a multinomial dirichlet negative binomial distribution this multivariate discrete distribution allows the direct calculation of seasonal welfare measures that are derived from an incomplete demand specification the welfare maximizing choice of activities is examined on a trail by trail basis using the results of the analysis our findings suggest that a mix of hiking and grazing activities provide the greatest social welfare

the role of portfolio constraints in the international propagation of shocks we study the comovement among stock prices and exchange rates in a three good three country centre periphery dynamic equilibrium model in which the centre s agents face portfolio constraints we characterize equilibrium in closed form for a broad class of portfolio constraints solving for stock prices terms of trade and portfolio holdings we show that portfolio constraints generate wealth transfers between the periphery countries and the centre which increase the comovement of the stock prices across the periphery we associate this excess comovement caused by portfolio constraints with the phenomenon known as contagion the model generates predictions consistent with other important empirical results such as amplification and flight to quality effects copyright 2008 wiley blackwell

the role of risk aversion and intertemporal substitution in dynamic consumption portfolio choice with recursive utility abstract our objective is to understand how risk aversion and elasticity of intertemporal substitution under recursive utility affect dynamic consumption portfolio decisions for a three date model with a stochastic interest rate we obtain an analytic solution for the optimal policies we find that in general consumption and portfolio decisions depend on both risk aversion and elasticity of intertemporal substitution the size of risk aversion relative to unity determines the sign of the intertemporal hedging portfolio while elasticity of intertemporal substitution affects only its magnitude the portfolio weight is independent of elasticity of intertemporal substitution only for the case of a constant investment opportunity set

an isomorphism between asset pricing models with and without linear habit formation we show an isomorphism between optimal portfolio selection or competitive equilibrium models with utilities incorporating linear habit formation and corresponding models without habit formation the isomorphism can be used to mechanically transform known solutions not involving habit formation to corresponding solutions with habit formation for example the constantinides 1990 and ingersoll 1992 solutions are mechanically obtained from the familiar merton solutions for the additive utility case without recourse to a bellman equation or first order conditions more generally recent solutions to portfolio selection problems with recursive utility and a stochastic investment opportunity set are readily transformed to novel solutions of corresponding problems with utility that combines recursivity with habit formation the methodology also applies in the context of hindy huang kreps 1992 preferences where our isomorphism shows that the solution obtained by hindy and huang 1993 can be mechanically transformed to dybvig s 1995 solution to the optimal consumption investment problem with consumption ratcheting this article presents a general method for solving asset pricing or portfolio selection models involving linear habit formation of the type studied by sundaresan 1989 constantinides 1990 detemple and zapatero 1991 ingersoll 1992 chapman 1998 and others the basic idea we pursue is that linear habit formation can be thought of as a redefinition of what constitutes consumption to include not only the current consumption rate but also a fictitious possibly negative consumption rate derived from past actual consumption by pricing out this fictitious consumption rate correctly the economy with linear habit formation can be mechanically transformed to an equivalent economy without habit formation this analysis simplifies and unifies existing results but also generates novel solutions for example together with the results of schroder and skiadas 1997 1999 our method produces optimal lifetime consumption and portfolio policies with preferences that combine recursive utility with habit formation under a stochastic

estimation and welfare analysis with large demand systems we develop an approach for estimating individual or household level preferences for a large set of quality differentiated goods and for constructing hicksian welfare measures within the demand system framework our approach uses a maximum simulated likelihood procedure to recover estimates of the structural parameters and a multistage monte carlo markov chain algorithm for constructing hicksian consumer surplus estimates we illustrate our approach with a recreation dataset consisting of day trips to 62 mid atlantic beaches

optimal portfolio choice under loss aversion this paper analyzes the optimal investment strategy for loss averse investors assuming a complete market and general ito processes for the asset prices the loss averse investor follows a partial portfolio insurance strategy when the investor s planning horizon is short less than 5 years he or she considerably reduces the initial portfolio weight of stocks compared to an investor with smooth power utility the empirical section of the paper estimates the level of loss aversion implied by historical u s stock market data using a representative agent model we find that loss aversion and risk aversion cannot be disentangled empirically

continuous time methods in finance a review and an assessment i survey and assess the development of continuous time methods in finance during the last 30 years the subperiod 1969 to 1980 saw a dizzying pace of development with seminal ideas in derivatives securities pricing term structure theory asset pricing and optimal consumption and portfolio choices during the period 1981 to 1999 the theory has been extended and modified to better explain empirical regularities in various subfields of finance this latter subperiod has seen significant progress in econometric theory computational and estimation methods to test and implement continuous time models capital market frictions and bargaining issues are being increasingly incorporated in continuous time theory the roots of modern continuous time methods in finance can be traced back to the seminal contributions of merton 1969 1971 1973b in the late 1960s and early 1970s merton 1969 pioneered the use of continuous time modeling in financial economics by formulating the intertemporal consumption and portfolio choice problem of an investor in a stochastic dynamic programming setting merton 1973b also showed how such a framework can be used to develop equilibrium asset pricing implications thereby significantly extending the asset pricing theory to richer dynamic settings and expanding the scope of applications of continuous time methods to study problems in financial economics 1 within a span of about 30 years from the publication of merton s inf luential papers continuous time methods have become an integral part of financial economics indeed in certain core areas in finance such as e g asset pricing derivatives valuation term structure theory and portfolio selection continuoustime methods have proved to be the most attractive way to conduct research and gain economic intuition the continuous time approach in these areas has produced models with a rich variety of testable implications the econometric theory for testing continuous time models has made rapid strides in the last decade and has thus kept pace with the impressive progress on the theoretical front one hopes that the actual empirical investigations and estimation using the new procedures will follow suit soon

benefit incidence of public recreation areas have the winners taken almost all this study presents a framework for investigating the benefit incidence of provision of public recreation opportunities the proportion of individuals who use outdoor recreation services increases with income and frequency of use differs by the users gender and life situation e g depending on whether they are students or older citizens the decomposition of distributive incidence shows that a bias in favor of high income groups may be accentuated when the perceived value of these services is taken into account in monetary terms we compare alternative strategies in terms of equity for improving recreation opportunities e g reduced distance to or increased acreage of recreation sites our results indicate that although these strategies improve the welfare distribution among the income groups a considerable proportion of benefits nevertheless accrue to high income groups

a monte carlo method for optimal portfolios this paper proposes a new simulation based approach for optimal portfolio allocation in realistic environments with complex dynamics for the state variables and large numbers of factors and assets a first illustration involves a choice between equity and cash with nonlinear interest rate and market price of risk dynamics intertemporal hedging demands significantly increase the demand for stocks and exhibit low volatility we then analyze settings where stock returns are also predicted by dividend yields and where investors have wealth dependent relative risk aversion large scale problems with many assets including the nasdaq sp500 bonds and cash are also examined the question of optimal portfolio allocation has been of long standing interest for academics and practitioners in finance while the mean variance analysis of markowitz 1952 is still commonly used among portfolio managers it has been well understood since merton 1971 that long term investors would prefer portfolios that include hedging components to protect against fluctuations in their investment opportunities prompted by the seminal papers of merton 1969 1971 and samuelson 1969 studies have explored various aspects of the dynamic portfolio problem when asset prices follow diffusion processes e g richard 1975 this literature has relied for the most part on a dynamic programming approach to the problem more recent contributions by pliska 1986 karatzas lehoczky and shreve 1987 and cox and huang 1989 have proposed an alternative resolution method based on martingale techniques in the context of this approach an optimal portfolio formula was derived by ocone and karatzas 1991 this expression involves expectations of random variables depending on j6erme b detemple is at boston university school of management and cirano rene

reinterpreting the dhsy 1978 consumption function with hindsight the justification for davidson hendry srba and yeo s dhsy s selection of their favoured equation is shown to be based upon contradicting assumptions about inflation the empirically supported model is argued not to have a theoretically justified error correction interpretation the exclusion of the intercept biases the error correction term such that it becomes significant and negative but undermines the theoretical plausibility of the long run target more generally the statistical need to include an intercept in any regression to avoid parameter bias is demonstrated the rise in inflation in the 1970s is not considered to be a credible explanation of the fall in the average propensity to consume apc from the 1950s and is shown to have questionable empirical support when a below unit income elasticity is allowed for the recent articles which have found support for dhsy s favoured formulation augmented by time varying parameters using the most contemporary uk data should be viewed with caution new interpretations for the dhsy model s persistent success are called for if it is not to be considered that dubious regressions have been resurrected

dynamic hedging and extreme asset co movements the paper investigates the portfolio allocation effects of increased asset co movements during market downturns we develop a model for the stock price process that allows for increased and asymmetric dependence between extreme return realizations we isolate the portfolio hedging demands that arise due to extreme co movements and find a substantial shift of the portfolio holdings toward the risk free asset we demonstrate that accounting for dependence between extreme events in portfolio decisions leads to significant economic gains that stem primarily from intertemporal hedging motives these findings are robust along alternative modeling assumptions of extreme co movements and conditional correlation

on the fluctuations in consumption and market returns in the presence of labor and human capital an equilibrium analysis abstract we examine the effects of human capital on consumption stock market and other fluctuations in a general equilibrium continuous time model a representative consumer worker investor derives utility from consumption and leisure a representative firm demands labor as the sole input to a stochastic production technology driven by general possibly nonmultiplicative shocks for cobb douglas utility and multiplicative shocks labor is nonstochastic and consumption and stock market volatility are equated as under no human capital deviations from this are analyzed for logarithmic utility and constant elasticity of substitution production technology cases are identified where the presence of labor causes consumption to be smoother than the stock market

a comparison of welfare estimates from four models for linking seasonal recreational trips to multinomial logit models of site choice we compare four methods of linking a site choice random utility model to a seasonal trip model the four approaches are those proposed by morey et al 1993 am j agric econom 75 578 592 hausman et al 1995 j public econom 56 1 30 parsons and kealy 1995 j environ econom management29 357 367 and feather et al 1995 j environ econom management29 214 227 we estimate the alternative models using a common data set and calculate a change in welfare for two policy scenarios across the models we find that there is little practical difference between the approaches of morey et al and hausman et al they are nearly the same mathematically and the welfare estimates in our empirical example are quite close the approaches of parsons and kealy and feather et al generated welfare estimates that were substantially different from the previous two approaches as well as from each other they also generated results that reveal the inconsistencies between their site choice and season trip models

optimality with hydropower system this paper studies an electricity producer s long term optimality in the case of a multireservoir hydropower system the model solves the optimal production process and trading strategy of electricity and weather derivatives by maximizing the utility from production and terminal water reservoir level the optimal trading strategy hedges the rainfall and electricity price uncertainties

nontraded asset valuation with portfolio constraints a binomial approach we provide a simple binomial framework to value american style derivatives subject to trading restrictions the optimal investment of liquid wealth is solved simultaneously with the early exercise decision of the nontraded derivative noshort sales constraints on the underlying asset manifest themselves in the form of an implicit dividend yield in the risk neutralized process for the underlying asset one consequence is that american call options may be optimally exercised prior to maturity even when the underlying asset pays no dividends applications to executive stock options eso are presented it is shown that the value of an eso could be substantially lower than that computed using the black scholes model we also analyze nontraded payoffs based on a price that is imperfectly correlated with the price of a traded asset the economics of asset pricing when one or more of the assets in the opportunity set are either subject to trading restrictions or entirely nontraded is a matter of great interest viewed from a practical perspective we have several important examples of such assets that are subject to trading restrictions pensions which represent perhaps the most significant of assets held by individual households are subject to trading restrictions it is typically the case that assets in pensions are not available for immediate consumption borrowing against pension assets is subject to significant direct and indirect costs by way of taxes and early withdrawal penalties human capital is another example housing investment is also illiquid and subject to significant transaction costs together pensions human capital and housing constitute a substantial part of a typical household s assets the significance of such nontraded assets for risk premia has already been noted by bewley 1982 there are other circumstances where lack of unrestricted trading plays an important role executive compensation plans usually take the this article was presented at boston university we would like to thank the editor bernard dumas and two anonymous referees for very helpful comments we also thank nalin kulatilaka and seminar participants for useful suggestions ganlin chang fei guan and carlton osakwe provided valuable research assistance j detemple acknowledges support from the social sciences and humanities research

optimal consumption investment policies with undiversifiable income risk and liquidity constraints abstract this paper examines the continuous time optimal consumption and portfolio choice of an investor having an initial wealth endowment and an uncertain stream of income from non traded assets the income stream is not spanned by traded assets and the investor is not allowed to borrow against future income so the financial market is incomplete we solve the corresponding stochastic control problem numerically with the markov chain approximation method prove convergence of the method and study the optimal policies in particular we find that the implicit value the agent attaches to an uncertain income stream typically is much smaller in this incomplete market than it is in the otherwise identical complete market our results suggest that this is mainly due to the presence of liquidity constraints

optimal investment and consumption when allowing terminal debt we analyze a dynamic optimization problem which involves the consumption and investment of an investor with constant relative risk aversion for consumption but with a risk aversion for final wealth which does not necessarily imply that terminal wealth must always be positive we require risk aversion for terminal wealth to be positive but not monotone there is a point of maximal risk aversion at zero wealth and the investor may continue to consume when wealth is negative using dual optimization methods we can derive explicit solutions and we find that the optimal solution differs in a fundamental way from the case where risk aversion is monotone it turns out that the optimal consumption function is convex and concave at different wealth levels and that the optimal investment strategy may no longer be monotone as a function of the remaining time to invest and consume

calibrating benefit function transfer to assess the conservation reserve program benefit transfer offers an inexpensive alternative to conducting an original study to determine economic value unfortunately benefit transfers can also result in biased welfare estimates in this paper we suggest a method of calibrating the benefit transfer to reduce this bias an empirical example to determine the benefits of the conservation reserve program on water based recreation illustrates the potentially large biases that can result if the transfer is not calibrated

saving out of different income categories in greece abstract the aim of the present paper is to investigate whether in the case of greece and within the framework of the existing national accounting system significantly different marginal propensities to save are attached to different income categories we establish that the marginal propensity to save out of property income is significantly higher in fact double than the marginal propensity to save out of agricultural income and income from wages and salaries of the other sectors of the economy

limiting environmental program contradictions a demand systems application to fishery management economically efficient natural resource policy requires the comprehensive management of environmental improvements over a system of sites use of multisite demand and benefit models can reduce the number and cost of environmental program contradictions in this paper we present a multisite demand model that incorporates several quality dimensions for a system of new mexico fishing sites use of the model permits managers to improve total welfare at lower cost by simultaneously distributing opportunity across all elements in resource users choice sets model results show that errors that result from independently adding values of interdependent program elements approach 50

a comparative study of portfolio insurance abstract this paper undertakes a comparative study of portfolio insurance under a variety of modeling strategies specifically we focus on portfolio insurers who derive utility from horizon wealth with marginal utility tending smoothly to infinity at some pre specified floor we solve for the optimal consumption portfolio wealth of these portfolio insurers and compare with constrained portfolio insurers and normal agents general equilibrium conditions are contrasted under pure exchange and production type models while the market price level is unambiguously increased under pure exchange under production the effect on market level is state dependent in both models the market volatility and risk premium are decreased by portfolio insurance the paper also investigates the possible relationship between portfolio insurance type trading strategies and market volatility

optimal consumption and portfolio policies when asset prices follow a diffusion process abstract we consider a consumption portfolio problem in continuous time under uncertainty a martingale technique is employed to characterize optimal consumption portfolio policies when there exist nonnegativity constraints on consumption and on final wealth we also provide a way to compute and verify optimal policies our verification theorem for optimal policies involves a linear partial differential equation unlike the nonlinear partial differential equation of dynamic programming the relationship between our approach and dynamic programming is discussed we demonstrate our technique by explicitly computing optimal policies in a series of examples in particular we solve the optimal consumption portfolio problem for hyperbolic absolute risk aversion utility functions when the asset prices follow a geometric brownian motion the optimal policies in this case are no longer linear when nonnegativity constraints on consumption and on final wealth are included by these examples one can see that our approach is much easier than the dynamic programming approach

the equilibrium allocation of diffusive and jump risks with heterogeneous agents abstract we study a two agent pure exchange equilibrium subject to both nondiversifiable diffusive and jump risks agents can trade in a financial market consisting of a stock market a money market and an insurance market for jump risk heterogeneity is introduced through different levels of relative risk aversion in the framework of standard expected utility we find the surprising result that the less risk averse agent purchases insurance contracts against jump risk from the more risk averse agent this equilibrium allocation is linked to the non linear wealth sharing rule in such an economy and preserves the wealth effects studied by dumas rev financ stud 2 1989 157 in the case of pure diffusive risk since the benchmark economy with homogeneous agents generates no excess uncertainty in the stock market we study the effect on excess volatility and excess jump size solely due to different levels of relative risk aversion we observe 3 excess uncertainty in jump sizes for a reasonable specification of economic fundamentals

valuation optimal asset allocation and retirement incentives of pension plans we provide a framework in which we link the valuation and asset allocation policies of defined benefits plans with the lifetime marginal productivity schedule of the worker and the pension plan formula in turn we examine the retirement policies that are implied by the primitives of the model and the value of pension obligations our model provides an explicit valuation formula for a stylized defined benefits plan the optimal asset allocation policies consist of the replicating portfolio of the pension liabilities and the growth optimum portfolio independent of the pension liabilities we show that the worker will retire when the ratio of pension benefits to current wages reaches a critical value which depends on the parameters of the pension plan and the discount rate using numerical techniques we analyze the feedback effect of retirement policies on the valuation of plans and on the asset allocation decisions article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

optimal asset allocation with fixed term securities we investigate the optimal asset allocation of an investor who can invest in a fixed term security that is only traded at time 0 using a generalized martingale approach we solve the investor s optimal portfolio problem determine the optimal allocation to fixed term securities and provide a representation of trading strategies in terms of a liquidity related derivative we apply our approach to two benchmark scenarios fixed term fixed rate bank deposits and unspanned closed end securities that can only be traded at time 0 we show that both can be key parts of the investor s optimal asset mix and we investigate the dependence of optimal allocations to fixed term investments implied liquidity premia and other characteristics on the underlying model parameters

a model of capital and crises we develop a model in which the capital of the intermediary sector plays a critical role in determining asset prices the model is cast within a dynamic general equilibrium economy and the role for intermediation is derived endogenously based on optimal contracting considerations low intermediary capital reduces the risk bearing capacity of the marginal investor we show how this force helps to explain patterns during financial crises the model replicates the observed rise during crises in sharpe ratios conditional volatility correlation in price movements of assets held by the intermediary sector and fall in riskless interest rates

optimal risk sharing with effort and project choice we consider first best risk sharing problems in which the agent can control both the drift effort choice and the volatility of the underlying process project selection in a model of delegated portfolio management it is optimal to compensate the manager with an option type payoff where the functional form of the option is obtained as a solution to an ordinary differential equation in the general case the optimal contract is a fixed point of a functional that connects the agent s and the principal s maximization problems we apply martingale duality methods familiar from optimal consumption investment problems

on equilibrium asset price processes in this article we derive necessary and sufficient conditions that must be satisfied by equilibrium asset price processes in apure exchange economy we examine a world in which asset prices follow a diffusion process asset markets are dynamically complete all investors maximize their state independent expected utility of consumption at some future date and investors have nonrandom exogenous income we show that it is necessary and suffcient that the coefficients of an equilibrium diffusion price process satisfy a partial differential equation and a boundary condition we also examine how the dynamics of asset prices are related to the shape of the representative investor s utility function through the boundary condition for example in a constant volatility economy the expected instantaneous return of the market portfolio is mean reverting if and only if the relative risk aversion of the representative investor is decreasing in terminal wealth

estimation and welfare calculations in a generalized corner solution model with an application to recreation demand the kuhn tucker model of wales and woodland 1983 provides a utility theoretic framework for estimating preferences over commodities for which individuals choose not to consume one or more of the goods due to the complexity of the model however there have been few applications in the literature and little attention has been paid to the problems of welfare analysis within the kuhn tucker framework this paper provides an application of the model to the problem of recreation demand in addition we develop and apply a methodology for estimating compensating variation relying on monte carlo integration to derive expected welfare changes

precautionary savings and the permanent income hypothesis this paper derives the explicit solution of a dynamic stochastic optimal consumption problem for infinitely lived agents whose preferences exhibit in the presence of non diversifiable labour income uncertainty a constant elasticity of intertemporal substitution and constant absolute risk aversion the constancy of the elasticity of intertemporal substitution which implies that marginal utility at zero consumption is infinite guarantees that the non negativity constraint on consumption is never binding along the optimal path the assumption of constant absolute risk aversion allows an explicit computation of human wealth and provides a simple representation of the precautionary savings motive

an intertemporal general equilibrium asset pricing model the case of diffusion information this paper provides sufficient conditions for the equilibrium price system and a vector of exogenously specified state variable processes to form a diffusion process in a pure exchange economy the conditions involve smoothness of agents utility functions and certain nice properties of the aggregate endowment process and the dividend processes of traded assets in place of the dynamic programming a martingale representation technique is utilized to characterize equilibrium portfolio policies this technique is useful even when there does not exist a finite dimensional markov structure in the economy and thus the markovian stochastic dynamic programming is not applicable a gents are shown to hold certain hedging mutual funds and the riskless asset in contrast to earlier results the market portfolio does not have a special role in hedging since the markets are dynamically complete when there exists a finite dimensional markov system in the economy the dimension of the hedging demand identified through the markovian dynamic programming may be much larger than that identified by the martingale method copyright 1987 by the econometric society

equilibrium prices in the presence of delegated portfolio management abstract this paper analyzes the asset pricing implications of commonly used portfolio management contracts linking the compensation of fund managers to the excess return of the managed portfolio over a benchmark portfolio the contract parameters the extent of delegation and equilibrium prices are all determined endogenously within the model we consider symmetric fulcrum performance fees distort the allocation of managed portfolios in a way that induces a significant and unambiguous positive effect on the prices of the assets included in the benchmark and a negative effect on the sharpe ratios asymmetric performance fees have more complex effects on equilibrium prices and sharpe ratios with the signs of these effects fluctuating stochastically over time in response to variations in the funds excess performance

dynamic asset allocation in a mean variance framework the aim of this article is to analyze the portfolio strategies that are mean variance efficient when continuous rebalancing is allowed between the current date 0 and the horizon t under very general assumptions when a zero coupon bond of maturity t exists the dynamic efficient frontier is a straight line the slope of which is explicitly characterized every dynamic mean variance efficient strategy can be viewed as buy and hold combinations of two funds the zero coupon bond of maturity t and a continuously rebalanced portfolio an appropriate dynamic strategy defining the latter is explicitly derived for two particular price processes and comparisons of the efficient frontiers static versus dynamic are provided in these cases

two trees with heterogeneous beliefs spillover effect of disagreement in a model where investors disagree about the fundamentals of two stocks the state price density depends on investor disagreements for both stocks especially the larger stock this implies that disagreement among investors in a large firm has a spillover effect on the pricing of other stocks owned by these investors the pricing effects of investor disagreements crucially depend on the average belief biases empirical findings support the novel model prediction of a disagreement spillover effect and help reconcile some mixed evidence in the literature

valuing food store access policy implications for the food stamp program food stamp recipients may lack access to larger stores reducing the availability of nutritious food reliance on smaller stores may have undesirable impacts policy alternatives include limiting food stamp redemption to larger stores and subsidizing store development i estimate that limiting redemption to supermarkets and grocery stores or supermarkets alone results in losses ranging from 499 2 million to 1 05 billion or 1 17 billion to 2 44 billion respectively annual loss in food stamp recipient welfare nationwide the impact of improving access is also significant ranging from 333 6 million to 931 2 million

optimal consumption wealth relationships derived by consumer intertemporal profit maximisation abstract this paper proposes an artificial intertemporal consumer profit maximisation problem that is simple to solve the optimal consumption function which is consistent with intertemporal utility maximisation is then generated directly from a specification of the consumer s instantaneous profit function

housing equity withdrawal and the average propensity to consume this study explains the behaviour of the average propensity to consume for durable and non durable expenditure in the uk during 1980 91 explicit attention is paid to the role of housing wealth and in particular equity withdrawal which has become more prominent as a result of financial deregulation long run relationships are estimated using the johansen procedure and from this reasonable short run equations are obtained the results indicate positive impact from housing equity withdrawal on the average propensity to consume

dynamic asset allocation for stocks bonds and cash closed form solutions for hara optimal portfolios are obtained in a dynamic portfolio optimization model in three assets stocks bonds and cash in a vasicek type model of stochastic interest rates with correlated stock prices the hara is a buy and hold combination of a zero coupon bond with maturity matching the investor s horizon and a crra mutual fund this simple characterization facilitates insights about investor behavior over time and provides explanations on the rational use of convex versus concave investment strategies the model illuminates clearly the role of the different market parameters and relative risk aversion in portfolio strategies

equilibrium open interest abstract this paper analyses what determines an individual investor s risk sharing demand for options and aggregating across investors what the equilibrium demand for options we find that agents trade options to achieve their desired skewness specifically we find that portfolio holdings boil down to a three fund separation theorem that includes a so called skewness portfolio that agents like to attain our analysis indicates also however that the common risk sharing setup used for option demand and pricing is incompatible with a stylized fact about open interest across strikes

on the aggregate value of recreational activities a nested price index approach using poisson demand systems an important consideration in the development ofregulations and policies that administer naturalresources in an area is the value of the non marketactivities supported by those lands little attentionhas been paid to the aggregate value of largegeographic areas this analysis builds autility theoretic price index and utilizes this indexto estimate an aggregate poisson demand to valuebackcountry recreational hiking opportunities innorthern california

dynamic asset allocation portfolio decomposition formula and applications a new decomposition of the optimal portfolio in dynamic models with von neumann morgenstern preferences and ito prices is established the formula rests on a change of numeraire that uses pure discount bonds as units of account the dynamic hedging demand has two components the first hedge insures against fluctuations in an optimally designed bond with a maturity date matching the investor s horizon the second hedge immunizes against fluctuations in the market price of risk in the bond numeraire various applications are examined new results concerning the behavior of extremely risk averse individuals the demand for bonds and its long horizon limit and the optimal portfolio in incomplete markets are derived the author 2009 published by oxford university press on behalf of the society for financial studies all rights reserved for permissions please email journals permissions oxfordjournals org oxford university press

a discrete count model of recreational demand abstract discrete choice models generate welfare measures resulting from environmental quality changes on a per trip basis instead of over a longer more policy relevant time period seasonal or annual welfare measures resulting from a quality change are often computed by multiplying each individual s per trip welfare measure by the number of trips the individual is forecasted to take at the new quality level these models are typically formulated so that increases in the quality of any site causes every individual to increase his or her participation this paper presents an alternative method of linking the discrete choice model to a demand model enabling welfare changes to be estimated in a conventional manner

consumption and portfolio choice under internal multiplicative habit formation this paper explores the optimal consumption and investment behavior of an individual who derives utility from the ratio between his consumption and an endogenous habit we obtain closed form policies under general utility functionals and stochastic investment opportunities by developing a nontrivial linearization to the budget constraint this enables us to explicitly characterize how habit formation affects the marginal propensity to consume and optimal stock bond investments we also show that in a setting that combines habit formation with epstein zin utility consumption no longer grows at unrealistically high rates at high ages and investments in risky assets decrease

optimal hedging in a dynamic futures market with a nonnegativity constraint on wealth abstract this paper examines the issue of optimal hedging demands for futures contracts from an investor who cannot freely trade his portfolio of primitive assets in the context of lognormal rather than normal returns and of a constant absolute risk aversion utility function in this context the nonnegativity constraint on wealth is binding and the optimal hedging demands are not identical with those encountered in the bulk of the literature which has largely overlooked this problem negative results concerning the derivation of equilibrium in the futures markets and the computation of the open interests then follow

on the optimality of path dependent structured funds the cost of standardization abstract this paper examines the suitability of an important class of standard financial structured products namely those whose performances are based on smoothing the return of a given risky underlying asset while providing a guarantee at maturity using various assumptions about the customers attitudes towards risk we show that such standardized products are not optimal even if the financial market volatility is constant as a by product we provide in particular the optimal portfolio value in the regret rejoice framework to go further with the notion of aversion of getting a return smaller than the risk free one using the notion of compensating variation we determine for the first time the monetary losses of providing these standardized products instead of the optimal ones to the customers we show that these monetary losses can be very significant when the volatility of the risky asset is stochastic from the operational point of view such results highly suggest to trade on the volatility index vix and or to introduce derivatives written on it when selling standardized funds in order to better meet investors needs and preferences

optimal contracts in a continuous time delegated portfolio management problem this article studies the contracting problem between an individual investor and a professional portfolio manager in a continuous time principal agent framework optimal contracts are obtained in closed form these contracts are of a symmetric form and suggest that a portfolio manager should receive a fixed fee a fraction of the total assets under management plus a bonus or a penalty depending upon the portfolio s excess return relative to a benchmark portfolio the appropriate benchmark portfolio is an active index that contains risky assets where the number of shares invested in each asset can vary over time rather than a passive index in which the number of shares invested in each asset remains constant over time fund managers compensation schemes in a delegated portfolio management setting have been of special interest to both academics and practitioners academic interest stems in part from the rapid growth of managed funds over the last two decades gompers and metrick 1998 report that by december 1996 mutual funds pension funds and other financial intermediaries held discretional control over more than half of the u s equity market it is thus of importance to study the impact of institutional trading on asset prices and to integrate into one model both asset pricing and delegated portfolio management compensation as advocated by brennan 1993 allen and santomero 1997 and allen 2001 it is also important to understand the relationship between a manager s trading strategies and his implicit incentives or career concerns see e g brown harlow and starks 1996 brown goetzmann and park 1997 chevalier and ellison 1999 and chen and pennacchi 2000 these concerns include internal promotion from a small to a large fund higher outside offers and the flow of money through the fund under management 1 the importance of fund manager compensation is also underscored by congressional passage in 1970 of the amendment to

a general equilibrium model of international portfolio choice we investigate in a two country general equilibrium model whether a bias in consumption towards domestic goods will necessarily lead to a preference for domestic securities we develop a model where investors are constrained to consume only from their domestic capital stock and where it is costly to transfer capital across countries in this model investors less risk averse than an investor with log utility bias their portfolios towards domestic assets investors more risk averse than log however prefer foreign assets thus this model suggests that it is unlikely that the portfolios observed empirically can be explained by the high proportion of domestic goods in total consumption we investigate in a two country general equilbrium model whether a bias in consumption toward domestic goods will necessarily lead to a preference for domestic assets in an investor s optimal portfolio we constrain investors to consume only from their domestic capital stock and introduce a proportional cost for transferring goods from one country this cost gives rise to endogenous deviations from the law of one price lop thus the home and foreign investors do not hold identical portfolios we show that an investor s optimal portfolio is biased towards domestic equity only if she is less risk averse than an investor with log utility investors with relative risk aversion greater than one exhibit a preference for the foreign asset this is because the exchange rate derived endogenously is negatively correlated with the return on the foreign asset and therefore the translated return on the foreign stock is less risky than that on the domestic stock thus the results of this model suggest that it is unlikely that the preference for domestic assets that is observed empirically can be explained by the high proportion of domestic goods in total consumption there exists a considerable body of literature documenting the gains from international diversification grubel 1968 was the first to propose that international diversification allows investors to attain lower return variances than those achievable by diversifying domestically this proposition relies on the correlation between stock indices across countries being significantly less

utilitarianism and fairness in portfolio positioning abstract the paper introduces the theory of optimal positioning of financial products it is illustrated in the context of long term intertemporal portfolio allocation and can be applied for example to asset allocation funds we embed this problem in location theory the portfolio is optimized within the investors risk aversion dimension for the crra utility functions we compute explicitly the distance functions for the first utilitarian criterion the average utility of the investors is maximized for the second one fairness criterion the choice of portfolio is optimized so that the average monetary loss due to the lack of customization is minimized given the distribution of investors risk aversion we provide a solution method and an algorithm to optimally position standardized portfolio along one of these two criteria

optimal investment with minimum performance constraints abstract we consider the portfolio problem of an investor whose wealth is constrained to be at least as large as that generated by investment in a stochastic benchmark portfolio using standard option pricing results the optimal portfolio policy of a hara utility investor is derived explicitly this policy is shown to be equivalent at any point in time to the investor s optimal unconstrained policy when he has contracted to paying out a proportion of the value of the benchmark portfolio at the terminal date this proportion which lies between zero and one is smaller the more likely it is that the investor will strictly outperform the benchmark over the investment horizon

brand choice and purchase frequency revisited an application to recreation behavior the role that total purchases play in determining the choice among brands has been considered in microeconomic theory for quite some time but for traditional goods only consumption of outdoor recreation is an unusual good most often measured using an individual s recreational trip adding the trips made on a number of choice occasions seems the obvious way to aggregate this good but doing so leads to several problems in defining a meaningful price index the hicks leontief conditions for aggregation suggest that trips to destinations may be thought of as brand choices on consumption occasions andthe continuous analogue to total purchases may in fact be the individual s total travel an empirical example of the model is used to estimate welfare impacts for a group of anglers

allocation of goods and services in vat this paper examines the allocation of goods and services in three hypothetical rates of the planned greek value added tax vat this allocation is based on six criteria i e the revenue criterion the luxuriousness criterion the regressivity of indirect taxes the relation of goods and services the criterion of import component of domestic demand and on the social criterion when drawn together the six criteria suggest a final classification of goods and services in the greek vat based on this final classification the microeconomic bases of the vat are estimated for the average greek household and also for households of different socioeconomic characteristics

consumption and portfolio policies with incomplete markets and short sale constraints the infinite dimensional case abstract we employ a martingale approach to study a dynamic consumption portfolio problem in continuous time with incomplete markets and short sale constraints we introduce a notion of minimax local martingale and transform the dynamic problem into a static problem of maximizing expected utility over the consumption bundles that satisfy a single budget constraint formed using that measure we establish the existence of and characterize the minimax local measure provide sufficient conditions for the dynamic consumption portfolio problem to have a solution and relate the optimal policies to the solution of quasi linear partial differential equation

optimal investment with s shaped utility and trading and value at risk constraints an application to defined contribution pension plan abstract in this paper we investigate an optimal investment problem under loss aversion s shaped utility and with trading and value at risk var constraints faced by a defined contribution dc pension fund manager we apply the concavification and dual control method to solve the problem and derive the closed form representation of the optimal terminal wealth in terms of a controlled dual state variable we propose a simple and effective algorithm for computing the initial dual state value the lagrange multiplier and the optimal terminal wealth theoretical and numerical results show that the var constraint can significantly impact the distribution of the optimal terminal wealth and may greatly reduce the risk of losses in bad economic states due to loss aversion

does option compensation increase managerial risk appetite this paper solves the dynamic investment problem of a risk averse manager compensated with a call option on the assets he controls under the manager s optimal policy the option ends up either deep in or deep out of the money as the asset value goes to zero volatility goes to infinity however the option compensation does not strictly lead to greater risk seeking sometimes the manager s optimal volatility is less with the option than it would be if he were trading his own account furthermore giving the manager more options causes him to reduce volatility managers with convex compensation schemes play an important role in financial markets this paper solves for the optimal dynamic investment policy for a risk averse manager paid with a call option on the assets he controls the paper focuses on how the option compensation impacts the manager s appetite for risk when he cannot hedge the option position on one hand the convexity of the option makes the manager shun payoffs that are likely to be near the money under the optimal policy the manager either significantly outperforms his benchmark or else incurs severe losses furthermore in examples of optimal trading strategies asset volatility goes to infinity as asset value goes to zero yet option compensation does not strictly lead to greater risk seeking as asset value grows large or if the evaluation date is far away the manager moderates asset risk for example if the manager has constant relative risk aversion crra asset volatility converges to the merton constant as asset value goes to infinity in some situations the manager actually chooses a lower asset volatility than he would if he were investing on his own because the leverage inherent in his option magnifies his exposure to the asset volatility in addition with all constant or decreasing absolute risk averse utility functions from the hyperbolic absolute risk averse hara class giving the manager more options causes him to reduce asset volatility in the crra case for example the manager targets a fixed volatility for his personal

non addictive habits optimal consumption portfolio policies abstract we formulate a model of preferences with non addictive habits where consumption is required to be non negative at all times but can fall below a standard of living index that aggregates past consumption we study the consumption portfolio problem taking account of the non negativity constraint on consumption and provide a constructive proof for the existence of an optimal policy on a finite time horizon 0 t we show that the consumption constraint binds up to an endogenous stopping time 0 t after which it remains slack until t a decomposition of constrained consumption involving an asian average strike capped call option is demonstrated

market timing with option implied distributions a forward looking approach we address the empirical implementation of the static asset allocation problem by developing a forward looking approach that uses information from market option prices to this end we extract constant maturity s p 500 implied distributions and transform them to the corresponding risk adjusted ones then we form optimal portfolios consisting of a risky and a risk free asset and evaluate their out of sample performance we find that the use of risk adjusted implied distributions times the market and makes the investor better off than if she uses historical returns distributions to calculate her optimal strategy the results hold under a number of evaluation metrics and utility functions and carry through even when transaction costs are taken into account not surprisingly the reported market timing ability deteriorated during the recent subprime crisis an extension of the approach to a dynamic asset allocation setting is also presented this paper was accepted by wei xiong finance