Robust consumption and portfolio choice with derivatives trading

Pengyu Wei, Charles Yang and Yi Zhuang

European Journal of Operational Research, 2023, vol. 304, issue 2, 832-850

Abstract: This paper analyzes the optimal consumption and portfolio choice problem for an ambiguity-averse investor with recursive preferences. The investor has access to both the stock and derivatives markets. The stock price process follows a stochastic volatility jump-diffusion model and the investor can have different levels of ambiguity about diffusion and jump risks, respectively. We obtain an exact analytical solution for investors with unit elasticity of intertemporal substitution of consumption and an approximate solution otherwise. We find that the optimal consumption policy is more sensitive to ambiguity aversion with respect to diffusion risks than the jump risk. The optimal exposures to diffusion and jump risks are significantly affected by the corresponding ambiguity aversions in the complete market; however, the optimal stock investment is relatively insensitive to jump misspecification in the incomplete market. We also show that taking into consideration ambiguity aversion to diffusion risks and participating in the derivatives market are essential to reduce the potential welfare loss, while the impact of jump misspecification is marginal.

Keywords: Finance; Robust consumption and portfolio choice; Ambiguity; Stochastic volatility; Derivatives (search for similar items in EconPapers)
Date: 2023
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0377221722003332
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:ejores:v:304:y:2023:i:2:p:832-850

DOI: 10.1016/j.ejor.2022.04.021

Access Statistics for this article

European Journal of Operational Research is currently edited by Roman Slowinski, Jesus Artalejo, Jean-Charles. Billaut, Robert Dyson and Lorenzo Peccati

More articles in European Journal of Operational Research from Elsevier
Bibliographic data for series maintained by Catherine Liu ().