Robust Portfolio Choice and Indifference Valuation

Abstract

We solve, theoretically and numerically, the problems of optimal portfolio choice and indifference valuation in a general continuous-time setting. The setting features (i) ambiguity and time-consistent ambiguity-averse preferences, (ii) discontinuities in the asset price processes, with a general and possibly infinite activity jump part next to a continuous diffusion part, and (iii) general and possibly nonconvex trading constraints. We characterize our solutions as solutions to backward stochastic differential equations (BSDEs). Generalizing Kobylanski's result for quadratic BSDEs to an infinite activity jump setting, we prove existence and uniqueness of the solution to a general class of BSDEs, encompassing the solutions to our portfolio choice and valuation problems as special cases. We provide an explicit decomposition of the excess return on an asset into a risk premium and an ambiguity premium, and a further decomposition into a piece stemming from the diffusion part and a piece stemming from the jump part. We further compute our solutions in a few examples by numerically solving the corresponding BSDEs using regression techniques.