A Computational Scheme for the Optimal Strategy in an Incomplete Market

22 Pages Posted: 11 Jan 2002  

Jussi Keppo

National University of Singapore - NUS Business School

Xu Meng

University of Michigan at Ann Arbor - Department of Industrial and Operations Engineering

Michael G. Sullivan

University of Michigan at Ann Arbor - Department of Mathematics

Multiple version iconThere are 2 versions of this paper

Date Written: November 18, 2006

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.

Keywords: utility maximization, incomplete markets, endowment uncertainty, numerical methods

JEL Classification: D52, G11

Suggested Citation

Keppo, Jussi and Meng, Xu and Sullivan, Michael G., A Computational Scheme for the Optimal Strategy in an Incomplete Market (November 18, 2006). Available at SSRN: https://ssrn.com/abstract=296223 or http://dx.doi.org/10.2139/ssrn.296223

Jussi Keppo (Contact Author)

National University of Singapore - NUS Business School ( email )

1 Business Link
Singapore, 117592
Singapore

Xu Meng

University of Michigan at Ann Arbor - Department of Industrial and Operations Engineering ( email )

1205 Beal Avenue
Ann Arbor, MI 48109
United States

Michael G. Sullivan

University of Michigan at Ann Arbor - Department of Mathematics ( email )

2074 East Hall
530 Church Street
Ann Arbor, MI 48109-1043
United States
+1 734 764 6420 (Phone)
+1 734 763 0937 (Fax)

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