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Dynamic portfolio choice and information trading with recursive utility

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  • Chen, Xingjiang
  • Ruan, Xinfeng
  • Zhang, Wenjun

Abstract

This paper examines a consumption-portfolio allocation and information trading problem with recursive utility in continuous time when stock returns are unobservable and when investors have to learn about it by using the stock price and the information products they purchase. We derive optimal consumption, portfolio policies, and information trading strategies in a semi-closed-form. Our quantitative analysis shows that ignoring information trading opportunities leads to significant economic losses for investors, particularly in a high-uncertainty case. More importantly, using the recursive utility, we innovatively find that the elasticity of intertemporal substitution (EIS) has a significant impact on an investors’ information trading. In particular, the lower the EIS of the investor, the more information products purchased by the investor. This paper provides an important economic foundation regarding trading information products in the financial market.

Suggested Citation

  • Chen, Xingjiang & Ruan, Xinfeng & Zhang, Wenjun, 2021. "Dynamic portfolio choice and information trading with recursive utility," Economic Modelling, Elsevier, vol. 98(C), pages 154-167.
    • Handle: RePEc:eee:ecmode:v:98:y:2021:i:c:p:154-167
    DOI: 10.1016/j.econmod.2021.02.020
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    References listed on IDEAS

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    2. Ma, Guiyuan & Siu, Chi Chung & Zhu, Song-Ping, 2022. "Portfolio choice with return predictability and small trading frictions," Economic Modelling, Elsevier, vol. 111(C).

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    More about this item

    Keywords

    Information trading; Recursive utility; Elasticity of intertemporal substitution; Portfolio choice; Optimal consumption; Learning;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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