Time-consistent portfolio optimization

Ling Peng and Peter E. Kloeden

European Journal of Operational Research, 2021, vol. 288, issue 1, 183-193

Abstract: This paper establishes a reusable framework, including a stochastic heterogeneous quasi-hyperbolic (SHQH) discount function, its non-standard Hamilton–Jacobi–Bellman equation (HJB) and its naive and precommitted solutions. To gurantee the broad generalities of the framework, we adopt a game theoretic approach in the sense of refraining from imposing functional specifications. This framework is the first which attains sub-game equilibrium in the presence of heterogeneous preferences (e.g. coexistence of present bias and age-related increases in self-control). As an example, this framework is used to optimize an insurance policy-holder’s asset allocation. The results show: (i) the sophisticated paradigm (formulated via the SHQH HJB) yields higher life insurance investment than the precommitted and naive paradigms (formulated via conventional optimization); (ii) the very instantaneous gratification that composes the resistance to delayed rewards also necessitates the insurance consumption to circumvent this resistance.

Keywords: heterogeneous quasi-hyperbolic preferences; life insurance; time-consistency (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ejores:v:288:y:2021:i:1:p:183-193

DOI: 10.1016/j.ejor.2020.05.061

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