Pre-commitment vs. time-consistent strategies for the generalized multi-period portfolio optimization with stochastic cash flows

Abstract

In this paper, we propose a multi-period portfolio optimization model with stochastic cash flows. Under the mean–variance preference, we derive the pre-commitment and time-consistent investment strategies by applying the embedding scheme and backward induction approach, respectively. We show that the time-consistent strategy is identical to the optimal open-loop strategy. Also, under the exponential utility preference, we develop the optimal strategy for multi-period investment, which is time-consistent. We show that the above two time-consistent strategies are equivalent in some cases. We compare the pre-commitment and time-consistent strategies under different situations with some numerical simulations. The results indicate that the time-consistent strategy is more stable and secure than pre-commitment strategy under the generalized mean–variance criterion.