Optimal Consumption and Investment Strategies with Stochastic Interest Rates

Carsten Sørensen and Claus Munk
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Carsten Sørensen: Department of Finance, Copenhagen Business School, Postal: Department of Finance, Copenhagen Business School, Solbjerg Plads 3, A5, DK-2000 Frederiksberg, Denmark

No 2000-9, Working Papers from Copenhagen Business School, Department of Finance

Abstract: We study the consumption and investment choice of a time-additive power utility

investor and demonstrate how theinvestor should optimally hedge changes in the op-

portunity set. The investor is allowed to invest in stocks and interest rate dependent

assets in a continuous-time dynamically complete market. In particular, we demon-

strate that under stochastic interest rates the investor optimally hedges changes in the

term structure of interest rates by investing in acoupon bond, or portfolio of bonds,

with a payment schedule that matches the forward-expected (i.e certainty equivalent)

consumption pattern. This is of conceptual importance since the hedge portfolio does

not depend on the speci c term structure dynamics (only through the consequences

for the optimal consumption pattern). We consider two explicit examples where the

dynamics of the term structure of interest rates are given by theVasicek-model and a

three-factor non-Markovian Heath-Jarrow-Morton model.

Keywords: Investment; Strategies (search for similar items in EconPapers)
JEL-codes: A00 (search for similar items in EconPapers)
Pages: 42 pages
Date: 2001-05-01
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Citations: View citations in EconPapers (4)

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Journal Article: Optimal consumption and investment strategies with stochastic interest rates (2004)
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