EconPapers    
Economics at your fingertips  
 

Optimal Consumption and Investment with Labor Income and European/American Capital Guarantee

Morten Tolver Kronborg ()
Additional contact information
Morten Tolver Kronborg: ATP (Danish Labour Market Supplementary Pension Scheme), Kongens Vænge 8, 3400 Hillerød, Denmark, and, Department of Mathematical Sciences, University of Copenhagen, Universitetsparken 5,2100 Copenhagen Ø, Denmark

Risks, 2014, vol. 2, issue 2, 1-24

Abstract: We present the optimal consumption and investment strategy for an investor, endowed with labor income, searching to maximize utility from consumption and terminal wealth when facing a binding capital constraint of a European (constraint on terminal wealth) or an American (constraint on the wealth process) type. In both cases, the optimal strategy is proven to be of the option-based portfolio insurance type. The optimal strategy combines a long position in the optimal unrestricted allocation with a put option. In the American case, where the investor is restricted to fulfill a capital guarantee at every intermediate time point over the interval of optimization, we prove that the investor optimally changes his budget constraint for the unrestricted allocation whenever the constraint is active. The strategy is explained in a step-by-step manner, and numerical illustrations are presented in order to support intuition and to compare the restricted optimal strategy with the unrestricted optimal counterpart.

Keywords: stochastic control; martingale method; option-based portfolio insurance; American put option; human capital; borrowing constraint; CRRA utility (search for similar items in EconPapers)
JEL-codes: C G0 G1 G2 G3 M2 M4 K2 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations View citations in EconPapers (1) Track citations by RSS feed

Downloads: (external link)
https://www.mdpi.com/2227-9091/2/2/171/pdf (application/pdf)
https://www.mdpi.com/2227-9091/2/2/171/ (text/html)

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:gam:jrisks:v:2:y:2014:i:2:p:171-194:d:36188

Access Statistics for this article

Risks is currently edited by Prof. Dr. J. David Cummins

More articles in Risks from MDPI, Open Access Journal
Bibliographic data for series maintained by XML Conversion Team ().

 
Page updated 2018-10-02
Handle: RePEc:gam:jrisks:v:2:y:2014:i:2:p:171-194:d:36188