Journal
MATHEMATICAL FINANCE
Volume 24, Issue 2, Pages 207-249Publisher
WILEY
DOI: 10.1111/j.1467-9965.2012.00522.x
Keywords
utility maximization; dynamic portfolio optimization; credit risk; Hamilton-Jacobi-Bellman equations; regime-switching models
Categories
Funding
- US National Science Foundation [DMS-0906919]
- Division Of Mathematical Sciences
- Direct For Mathematical & Physical Scien [1149692] Funding Source: National Science Foundation
Ask authors/readers for more resources
We consider a portfolio optimization problem in a defaultable market with finitely-many economical regimes, where the investor can dynamically allocate her wealth among a defaultable bond, a stock, and a money market account. The market coefficients are assumed to depend on the market regime in place, which is modeled by a finite state continuous time Markov process. By separating the utility maximization problem into a predefault and postdefault component, we deduce two coupled Hamilton-Jacobi-Bellman equations for the post- and predefault optimal value functions, and show a novel verification theorem for their solutions. We obtain explicit constructions of value functions and investment strategies for investors with logarithmic and Constant Relative Risk Aversion utilities, and provide a precise characterization of the directionality of the bond investment strategies in terms of corporate returns, forward rates, and expected recovery at default. We illustrate the dependence of the optimal strategies on time, losses given default, and risk aversion level of the investor through a detailed economic and numerical analysis.
Authors
I am an author on this paper
Click your name to claim this paper and add it to your profile.
Reviews
Recommended
No Data Available