Affine long term yield curves: An application of the Ramsey rule with progressive utility

Nicole El Karoui (), Caroline Hillairet () and Mohamed Mrad ()
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Nicole El Karoui: LPMA, UMR CNRS 6632, Université Pierre et Marie Curie, France;
Caroline Hillairet: CMAP, UMR CNRS 7641, école Polytechnique, France
Mohamed Mrad: LAGA, UMR CNRS 7539, Université Paris 13, France

Journal of Financial Engineering (JFE), 2014, vol. 01, issue 01, 1-24

Abstract: The purpose of this paper relies on the study of long-term affine yield curves modeling. It is inspired by the Ramsey rule of the economic literature, that links discount rate and marginal utility of aggregate optimal consumption. For such a long maturity modelization, the possibility of adjusting preferences to new economic information is crucial, justifying the use of progressive utility. This paper studies, in a framework with affine factors, the yield curve given from the Ramsey rule. It first characterizes consistent progressive utility of investment and consumption, given the optimal wealth and consumption processes. A special attention is paid to utilities associated with linear optimal processes with respect to their initial conditions, which is for example the case of power progressive utilities. Those utilities are the basis point to construct other progressive utilities generating non linear optimal processes but leading yet to still tractable computations. This is of particular interest to study the impact of initial wealth on yield curves.

Keywords: Progressive utility with consumption; market consistency; portfolio optimization; Ramsey rule; affine yields curves (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (14)

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DOI: 10.1142/S2345768614500032

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