Optimal investment with insurable background risk and nonlinear portfolio allocation frictions

Hugo E. Ramirez and Rafael Serrano ()

Abstract: We study investment and insurance demand decisions for an agent in a theoretical continuous-time expected utility maximization model that combines risky assets with an (exogenous) insurable background risk. This risk takes the form of a jump-diffusion process with negative jumps in the return rate of the (self-financed) wealth. The main distinctive feature of our model is that the agent's decision on portfolio choice and insurance demand causes nonlinear friction in the dynamics of the wealth process. We use the dynamic programming approach to find optimality conditions under which the agent assumes the insurable risk entirely, or partially, or purchases total insurance against it. In particular, we consider differential and piece-wise linear portfolio allocation frictions, with differential borrowing and lending rates as our most emblematic example. Finally, we present a mutual-fund separation result and illustrate our results with several numerical examples when the adverse jump risk has Beta distribution.

Date: 2023-03
New Economics Papers: this item is included in nep-des, nep-rmg and nep-upt
References: Add references at CitEc
Citations:

Downloads: (external link)
http://arxiv.org/pdf/2303.04236 Latest version (application/pdf)

Related works:
Journal Article: Optimal investment with insurable background risk and nonlinear portfolio allocation frictions (2025)
Working Paper: Optimal investment with insurable background risk and nonlinear portfolio allocation frictions (2023)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:2303.04236

Access Statistics for this paper

More papers in Papers from arXiv.org
Bibliographic data for series maintained by arXiv administrators ().