Optimal investment-consumption problem: post-retirement with minimum guarantee (Q2212151)

A retiree postpones the annuitisation until time \(T\). The wealth can be invested in a Black-Scholes market with an investment restriction. There is consumption of the wealth at a rate lying in an interval \([C_2,C_1]\). The wealth process thus fulfils \[ d X_s = \{[\pi_s(\mu - r) + r] X_s - c_s\}\;d s + \sigma \pi_s X_t \;d B_s\;,\] where \(r\), \(\mu\), \(\sigma\) are the parameters of the Black-Scholes model, \(\pi_s \in [0,L]\) is the fraction invested in the risk asset and \(c_s \in [C_2,C_1]\) is the consumption rate. In particular, short selling of the risky asset is not allowed, but if \(L > 1\), loaning is permitted. There is a minimal wealth \(S\) for time \(T\) and a target wealth \(F\). That is, the wealth process has to fulfil \(X_T \ge S\). The value of an investment-consumption strategy is \[ \kappa \int_0^T \eta_t (C_1 - c_t)^2 \; d t + \eta_T (F- X_T)^2\;,\] where \(\eta_t\) is the probability that the retiree is still alive at time \(t\) and \(\kappa\) is a weight. The quadratic utility has the effect that the strategy is chosen such that \(X_t \le F\). That is, one is not interested in a higher pension after time \(T\). It is shown that the value function fulfils the corresponding Hamilton-Jacobi-Bellman equation. The equation has to be solved in the area where \[C_2 - (C_2 - r S)e^{-r(T-t)} \le r x \le C_1 + (r F - C_1)e^{-r(T-t)}\;.\] This is, because investment in the risky asset is not allowed if the lower bound is reached and, at the upper bound, not investing in the risky asset yields the optimal value zero. A numerical method is presented. The idea is to transform the domain to a rectangle in order to apply a finite difference method.