Duality in optimal consumption--investment problems with alternative data

arXiv2210.08422MaRDI QIDQ6414062FDOQ6414062

Publication date: 15 October 2022

Abstract: In this paper, we investigate an optimal consumption--investment problem in which the unobserved stock trend is modulated by a hidden Markov chain, representing different economic regimes. In the classical approach, the hidden state is estimated from historical asset prices, but recent technology enables investors to consider alternative data when making decisions. These include social media commentary, expert opinions, pandemic data, and GPS data, which originate outside of the standard repertoire of market data but are considered useful for predicting stock trends. We model the asset price and alternative data series as a diffusion process and a jump-diffusion process, respectively. By incorporating the alternative data into the filtering process, we extend the Wonham filter to a degenerate jump diffusion with L'{e}vy-type jumps. This introduces major analytical challenge to the corresponding stochastic control problem. We address this by taking a novel duality approach. We link the dual problem to an optimization problem over a set of equivalent local martingale measures and devise a methodology to obtain the optimal solution using a filtering technique with the alternative data. We show that the dual problem provides a unique smooth solution for constant relative risk aversion (CRRA) utility functions. In addition, we obtain an explicit feedback optimal consumption--investment strategy through the advantages provided by the alternative data.

This page was built for publication: Duality in optimal consumption--investment problems with alternative data

Report a bug (only for logged in users!)Click here to report a bug for this page (MaRDI item Q6414062)