Portfolio decision with a quadratic utility and inflation risk

Abstract

Abstract This paper considers a portfolio selection problem with a quadratic utility of consumption, which is symmetric with respect to a bliss point. At bliss point, the utility function has its maximum value and further consumption lowers the utility. In the presence of inflation risk, we introduce an inflation-linked index bond to manage the inflation risk and derive explicit expressions for the optimal consumption and portfolios by applying duality method. Based on quantitative results, we see that inflation-linked index bond plays an important role in choosing consumption and portfolio rules.

Keywords

• Martingale duality method
• Portfolio selection
• Quadratic utility
• Inflation risk
• Inflation-linked index bond