Portfolio and Consumption Decisions Under Mean-Revering Returns: An Exact Solution for Complete Markets

36 Pages Posted: 12 Nov 2008

See all articles by Jessica A. Wachter

Jessica A. Wachter

University of Pennsylvania - Finance Department; National Bureau of Economic Research (NBER)

Multiple version iconThere are 3 versions of this paper

Date Written: November 2001

Abstract

This paper solves, in closed form, the optimal portfolio choice problem for an investor with utility over consumption under mean-reverting returns. Previous solutions either require approximations, numerical methods, or the assumption that the investor does not consume over his lifetime. This paper breaks the impasse by assuming that markets are complete. The solution leads to a new understanding of hedging demand and of the behavior of the approximate log-linear solution. The portfolio allocation takes the form of a weighted average and is shown to be analogous to duration for coupon bonds. Through this analogy, the notion of investment horizon is extended to that of an investor who consumes at multiple points in time.

Suggested Citation

Wachter, Jessica A., Portfolio and Consumption Decisions Under Mean-Revering Returns: An Exact Solution for Complete Markets (November 2001). NYU Working Paper No. S-MF-01-04, Available at SSRN: https://ssrn.com/abstract=1300239

Jessica A. Wachter (Contact Author)

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States
215-898-7634 (Phone)
215-898-6200 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
20
Abstract Views
450
PlumX Metrics