Article ID Journal Published Year Pages File Type
5091548 Journal of Banking & Finance 2013 27 Pages PDF
Abstract
We characterize the solution to the consumption and investment problem of a power utility investor in a continuous-time dynamically complete market with stochastic changes in the opportunity set. 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 equals the forward-expected (i.e. certainty equivalent) consumption pattern. Numerical experiments with two different specifications of the term structure dynamics (the Vasicek model and a three-factor non-Markovian Heath-Jarrow-Morton model) suggest that the hedge portfolio is more sensitive to the form of the term structure than to the dynamics of interest rates.
Related Topics
Social Sciences and Humanities Economics, Econometrics and Finance Economics and Econometrics
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