A Computational Scheme for the Optimal Strategy in an Incomplete Market

Posted: 28 Mar 2007

See all articles by Jussi Keppo

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

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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

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. Journal of Economic Dynamics and Control, Forthcoming. Available at SSRN: https://ssrn.com/abstract=972700

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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