Portfolio optimization in the case of an exponential utility function and in the presence of an illiquid asset
Abstract
We study an optimization problem for a portfolio with a riskfree, a liquid risky, and an illiquid asset which is sold in an exogenous random moment of time with a prescribed liquidation time distribution. Problems of such type lead to three dimensional nonlinear partial differential equations (PDEs) on the value function. We study the optimization problem with a utility function of a CARA type, i.e. with negative and positive exponential utility functions (EXPn and EXPp). It is well known that both the LOG and the EXPn utility functions are connected with the HARA utility function by means of a limiting procedure: in the first case the parameter of a HARA utility function is going to zero and in the second case to infinity. In our previous papers devoted to the optimization problem with a HARA and LOG utility functions we proved that also the corresponding analytical and Lie algebraic structures are connected with the same limiting procedure. In this paper we show that the case of EXPn utility function differs from the case of the HARA utility and is not connected to the HARA case by the limiting procedure. We carry out the Lie group analysis of the PDEs for the cases EXPn and EXPp utility functions and proved that they are connected by a onetoone analytical substitution and are identical from the economical, analytical or Lie algebraic point of view. The complete set of nonequivalent group invariant reductions to two dimensional PDEs is provided for the three dimensional PDE with the EXPn utility function in accordance with an optimal system of sub algebras of the admitted Lie algebra. We prove that in one case the invariant reduction is consistent with the boundary condition. We can use the reduced two dimensional PDE to study the properties of the optimal solution and the investment  consumption strategies.
 Publication:

arXiv eprints
 Pub Date:
 October 2019
 arXiv:
 arXiv:1910.07417
 Bibcode:
 2019arXiv191007417B
 Keywords:

 Quantitative Finance  Portfolio Management;
 Quantitative Finance  Mathematical Finance;
 22E60;
 35Q93;
 35K55;
 91G10
 EPrint:
 22 pages, 1 Table. arXiv admin note: text overlap with arXiv:1512.06295