The robust Merton problem of an ambiguity averse investor

DOI10.1007/S11579-016-0168-6zbMATH Open1404.91240arXiv1502.02847OpenAlexW72386360MaRDI QIDQ506375FDOQ506375

Sara Biagini, Mustafa Ç. Pınar

Publication date: 31 January 2017

Published in: Mathematics and Financial Economics (Search for Journal in Brave)

Abstract: We derive a closed form portfolio optimization rule for an investor who is diffident about mean return and volatility estimates, and has a CRRA utility. The novelty is that confidence is here represented using ellipsoidal uncertainty sets for the drift, given a volatility realization. This specification affords a simple and concise analysis, as the optimal portfolio allocation policy is shaped by a rescaled market Sharpe ratio, computed under the worst case volatility. The result is based on a max-min Hamilton-Jacobi-Bellman-Isaacs PDE, which extends the classical Merton problem and reverts to it for an ambiguity-neutral investor.

Full work available at URL: https://arxiv.org/abs/1502.02847

zbMATH Keywords

robust optimizationvolatility uncertaintyHamilton-Jacobi-Bellman-Isaacs equationellipsoidal uncertainty on mean returnsMerton problem

Mathematics Subject Classification ID

PDEs in connection with game theory, economics, social and behavioral sciences (35Q91) Portfolio theory (91G10) Minimax problems in mathematical programming (90C47)

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Cited In (38)

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