Time-inconsistency with rough volatility

Bingyan Han and Hoi Ying Wong

Papers from arXiv.org

Abstract: In this paper, we consider equilibrium strategies under Volterra processes and time-inconsistent preferences embracing mean-variance portfolio selection (MVP). Using a functional It\^o calculus approach, we overcome the non-Markovian and non-semimartingale difficulty in Volterra processes. The equilibrium strategy is then characterized by an extended path-dependent Hamilton-Jacobi-Bellman equation system under a game-theoretic framework. A verification theorem is provided. We derive explicit solutions to three problems, including MVP with constant risk aversion, MVP for log returns, and a mean-variance objective with a linear controlled Volterra process. We also thoroughly examine the effect of volatility roughness on equilibrium strategies. Numerical experiments demonstrate that trading rules with rough volatility outperform the classic counterparts.

Date: 2019-07, Revised 2021-12
New Economics Papers: this item is included in nep-dge and nep-ore
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Published in SIAM Journal on Financial Mathematics, 2021

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Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:1907.11378

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