A Diffusion Model for Long-Term Optimization in the Presence of Stochastic Interest and Inflation Rates

Farid Mkaouar (), Jean-Luc Prigent and Ilyes Abid ()
Additional contact information
Farid Mkaouar: Ecole Nationale d’Assurance (Enass)
Ilyes Abid: Institut Supérieur de Commerce de Paris

Computational Economics, 2019, vol. 54, issue 1, No 16, 367-417

Abstract: Abstract We consider the long term portfolio management problem, under stochastic rates and inflation risk. Five basic financial assets are considered: a money market account (the cash), an inflation-protected cash, a financial stock index and two different bonds with constant maturity. The first one corresponds to a nominal bond while the second one is an inflation-indexed bond. We consider constant maturation bonds, which allows to obtain a bond/stock ratio increasing with time (when there exists no inflation). This nice property is in accordance with popular advice. In this framework, we provide the general solution of the expected utility maximization. This intertemporal optimization problem is solved by using the martingale approach. We detail in particular the CRRA case. We determine also the optimal portfolio weights and analyze the solutions. We show in particular that the weight invested on the inflation-indexed bond increases with the relative risk aversion and also when the time horizon increases, which corresponds to a stronger demand for inflation hedging for longer maturities. Such feature illustrates the importance of introducing inflation-indexed bonds on financial markets.

Keywords: Portfolio optimization; Stochastic interest rate; Stochastic inflation; Inflation-indexed bonds (search for similar items in EconPapers)
JEL-codes: C61 G11 G12 (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://link.springer.com/10.1007/s10614-017-9742-0 Abstract (text/html)
Access to the full text of the articles in this series is restricted.

Related works:
Working Paper: A Diffusion Model for Long-Term Optimization in the Presence of Stochastic Interest and Inflation Rates (2019)
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:kap:compec:v:54:y:2019:i:1:d:10.1007_s10614-017-9742-0

Ordering information: This journal article can be ordered from
http://www.springer. ... ry/journal/10614/PS2

DOI: 10.1007/s10614-017-9742-0

Access Statistics for this article

Computational Economics is currently edited by Hans Amman

More articles in Computational Economics from Springer, Society for Computational Economics Contact information at EDIRC.
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().