Dynamic asset allocation with relative wealth concerns in incomplete markets

Holger Kraft, André Meyer-Wehmann and Frank Thomas Seifried

Journal of Economic Dynamics and Control, 2020, vol. 113, issue C

Abstract: In dynamic portfolio choice problems, stochastic state variables such as stochastic volatility lead to adjustments of the optimal stock demand referred to as hedge terms or Merton-Breeden terms. By deriving an explicit solution in a two-agent framework with a stochastic opportunity set, we show that relative wealth concerns give rise to new hedge terms beyond the ordinary ones. This is because the agents hedge against both exogenous changes in the state variable and endogenous decisions of the other agent. Depending on the parametrization of the model, these new terms can significantly change the investors’ hedging demands. We also show that both heterogeneity in risk aversion or relative wealth concerns can have similar effects on the heterogeneity in portfolio decisions. Formally, we study a non-cooperative, non-zero sum stochastic differential game for which we prove a verification theorem in a setting with an unspanned state variable.

Keywords: Portfolio choice; Social preferences; Fund manager; Growth optimal portfolio; Stochastic differential game; Verification theorem; Incomplete markets; Stochastic opportunity set (search for similar items in EconPapers)
JEL-codes: C61 C73 G11 (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0165188920300270
Full text for ScienceDirect subscribers only

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:113:y:2020:i:c:s0165188920300270

DOI: 10.1016/j.jedc.2020.103857

Access Statistics for this article

Journal of Economic Dynamics and Control is currently edited by J. Bullard, C. Chiarella, H. Dawid, C. H. Hommes, P. Klein and C. Otrok

More articles in Journal of Economic Dynamics and Control from Elsevier
Bibliographic data for series maintained by Catherine Liu ().