A Computational Scheme for the Optimal Strategy in an Incomplete Market
22 Pages Posted: 11 Jan 2002
Date Written: November 18, 2006
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.
Keywords: utility maximization, incomplete markets, endowment uncertainty, numerical methods
JEL Classification: D52, G11
Suggested Citation: Suggested Citation