Optimal consumption and portfolio choice with ambiguous interest rates and volatility (Q825169)

The authors of the paper deal with the problem of consumption-saving choice in a stochastic model with uncertainty. In their model, there are two assets in which one can invest: a risky stock and a risk-free bond. An agent has to choose his/her investment and consumption path over a finite horizon, i.e. he/she has to find a strategy that maximizes the functional \[ E_P \left[ \int_0^T u(c_s) ds + \Phi(T, X_T)\right], \] where \(u\) is an instantaneous utility function, \(\Phi\) is a utility from the final wealth \(X_T\) and \(c\) is a consumption path. It is also assumed that in the model there is an uncertainty about risk-free interest rate and returns (and volatility) of risky asset. It is assumed that each of these parameters lies in some intervals (i.e. \(r\in [\underline{r}, \overline{r}]\), \(\mu\in [\underline{\mu}, \overline{\mu}]\), \(\sigma\in [\underline{\sigma}, \overline{\sigma}]\), where \(r\) is the interest rate, \(\mu\) is the expected return of the risky asset and \(\sigma\) is its volatility). There is also uncertainty about probability measure \(P\), which can belong to some set \(\mathcal{P}\). The main result of the authors is Theorem 3, which gives the solution to the optimization problem. The authors prove that under some conditions concerning the possible values of the parameters \(r\), \(\mu\), and \(\sigma\) it is optimal for the agent to choose the investment path in which all the wealth is invested in the risky asset. To prove this statement the authors use necessary conditions from the Hamilton-Jacobi-Bellman equations (Theorems 2 and 3).