Minimizing the Probability of Lifetime Drawdown Under Constant Consumption
26 Pages Posted: 21 May 2016
Date Written: May 19, 2016
We assume that an individual invests in a financial market with one riskless and one risky asset, with the latter's price following geometric Brownian motion as in the Black-Scholes model. Under a constant rate of consumption, we find the optimal investment strategy for the individual who wishes to minimize the probability that her wealth drops below some fixed proportion of her maximum wealth to date, the so-called probability of lifetime drawdown. If maximum wealth is less than a particular value, m*, then the individual optimally invests in such a way that maximum wealth never increases above its current value. By contrast, if maximum wealth is greater than m* but less than the safe level, then the individual optimally allows the maximum to increase to the safe level.
Keywords: Optimal investment, stochastic optimal control, probability of drawdown
JEL Classification: C61, G02, G11
Suggested Citation: Suggested Citation