Optimal Consumption and Investment Strategies with Stochastic Interest Rates

By Claus Munk, Carsten Sørensen. 2004

134 citations recorded by the source corpus.

We characterize the solution to the consumption and investment problem of a time-additive power utility investor in a continuous-time dynamically complete market with stochastic changes in the opportunity set. It is demonstrated that under stochastic interest rates the investor optimally hedges against changes in the term structure of interest rates by investing in a coupon 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 only depends on the specic term structure dynamics through the consequences for the optimal consumption pattern. We consider two explicit examples where the term structure dynamics are given by the Vasicek model and a three factor non-Markovian Heath-Jarrow-Morton model.

Subfields: Economics and Econometrics, Finance

View Paper: https://www.semanticscholar.org/paper/709b61afdbd98a582bc614f3580f7e1e3689200d

How researchers see this paper

The researchers whose trusted networks rank it highest, strongest advocate first. Every researcher gets a different order.

In Economics and Econometrics

In Finance

Citations in the corpus

Optimal portfolios when volatility can jump (2008, background): “Kraft (2003) and Korn and Kraft (2004) focus on the technical aspects of such continuous-time asset allocation problems in the context of stochastic investment opportunity sets.”
Dynamic asset allocation with stochastic income and interest rates. (2010, unknown): “Other studies of portfolio choice with uncertain interest rates include Brennan, Schwartz, and Lagnado (1997), Campbell and Viceira (2001), Detemple, Garcia, and Rindisbacher (2003), and Munk and Sørensen (2004).”
Portfolios and risk premia for the long run. (2012, unknown): “mkov and Schachermayer (1999), as well as Castan˜edaLeyva and Hernandez-Hern´andez (2005) for a setting similar to the one in this paper. 3Kim and Omberg (1996), Brennan and Xia ( 2002), Wachter ( ), Munk and Sørensen (2004), Liu (2007), compute optimal portfolios explicitly for certain models. 4 Fl”
Correlation Risk and Optimal Portfolio Choice (2010, background): “This period is called the "golden age of capitalism" (see Rajan and Zingales, 2001) and was characterized by high average per capita equity market capitalizations and relatively integrated financial markets. "Following this peak" - Goetzmann, Li, and Rouwenhorst (2005) argue - "the only constant is ”