A0247
Title: Investment consumption optimization with transaction cost and learning about return predictability
Authors: Tak Kuen Siu - Macquarie University (Australia)
Ning Wang - Australian National University (Australia) [presenting]
Abstract: An investment and consumption optimization problem is investigated in continuous-time settings, where the expected rate of return from a risky asset is predictable with an observable factor and an unobservable factor. Based on observable information, a decision-maker learns about the unobservable factor while making optimal investment and consumption decisions. Both factors are supposed to follow a mean-reverting process. Also, the assumption is relaxed for perfect liquidity of the risky asset through incorporating proportional transaction costs that are incurred in trading the risky asset. In such a way, a form of friction posing liquidity risk to the investor is examined. Dynamic programming principles coupled with an HJB equation are adopted to discuss the problem. Applying an asymptotic method with small transaction costs being taken as a perturbation parameter, the frictional value function is determined by solving the first and second corrector equations. For the numerical implementation of the proposed approach, a Monte Carlo-simulation-based approximation algorithm is adopted to solve the second corrector equation. Finally, numerical examples and their economic interpretations are discussed.
