Optimal consumption under relaxed benchmark tracking and consumption drawdown constraint

Lijun Bo, Yijie Huang, Kaixin Yan and Xiang Yu

Papers from arXiv.org

Abstract: This paper studies an optimal consumption problem with both relaxed benchmark tracking and consumption drawdown constraint, leading to a stochastic control problem with dynamic state-control constraints. In our relaxed tracking formulation, it is assumed that the fund manager can strategically inject capital to the fund account such that the total capital process always outperforms the benchmark process, which is described by a geometric Brownian motion. We first transform the original regular-singular control problem with state-control constraints into an equivalent regular control problem with a reflected state process and consumption drawdown constraint. By utilizing the dual transform and the optimal consumption behavior, we then turn to study the linear dual PDE with both Neumann boundary condition and free boundary condition in a piecewise manner across different regions. Using the smoothfit principle and the super-contact condition, we derive the closed-form solution of the dual PDE, and obtain the optimal investment and consumption in feedback form. We then prove the verification theorem on optimality by some novel arguments with the aid of an auxiliary reflected dual process and some technical estimations. Some numerical examples and financial insights are also presented.

Date: 2024-10
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