Robust utility maximization in a stochastic factor model

Daniel Hernández-Hernández and Alexander Schied

No 2006-007, SFB 649 Discussion Papers from Humboldt University Berlin, Collaborative Research Center 649: Economic Risk

Abstract: We give an explicit PDE characterization for the solution of a robust utility maximization problem in an incomplete market model, whose volatility, interest rate process, and long-term trend are driven by an external stochastic factor process. The robust utility functional is defined in terms of a HARA utility function with negative risk aversion and a dynamically consistent coherent risk measure, which allows for model uncertainty in the distributions of both the asset price dynamics and the factor process. Our method combines two recent advances in the theory of optimal investments: the general duality theory for robust utility maximization and the stochastic control approach to the dual problem of determining optimal martingale measures.

Date: 2005
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