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BETTER THAN DYNAMIC MEAN-VARIANCE: TIME INCONSISTENCY AND FREE CASH FLOW STREAM

Mathematical finance, 2012-04, Vol.22 (2), p.346-378 [Peer Reviewed Journal]

2010 Wiley Periodicals, Inc. ;ISSN: 0960-1627 ;EISSN: 1467-9965 ;DOI: 10.1111/j.1467-9965.2010.00461.x

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  • Title:
    BETTER THAN DYNAMIC MEAN-VARIANCE: TIME INCONSISTENCY AND FREE CASH FLOW STREAM
  • Author: Cui, Xiangyu ; Li, Duan ; Wang, Shouyang ; Zhu, Shushang
  • Subjects: Cash flow ; Decision theory ; Dynamic models ; Dynamic programming ; free cash flow stream ; Investment policy ; Investors ; mean-variance ; Mean-variance policy ; Portfolio investments ; Portfolio selection ; Studies ; time consistency ; Variance ; Wealth
  • Is Part Of: Mathematical finance, 2012-04, Vol.22 (2), p.346-378
  • Description: As the dynamic mean‐variance portfolio selection formulation does not satisfy the principle of optimality of dynamic programming, phenomena of time inconsistency occur, i.e., investors may have incentives to deviate from the precommitted optimal mean‐variance portfolio policy during the investment process under certain circumstances. By introducing the concept of time inconsistency in efficiency and defining the induced trade‐off, we further demonstrate in this paper that investors behave irrationally under the precommitted optimal mean‐variance portfolio policy when their wealth is above certain threshold during the investment process. By relaxing the self‐financing restriction to allow withdrawal of money out of the market, we develop a revised mean‐variance policy which dominates the precommitted optimal mean‐variance portfolio policy in the sense that, while the two achieve the same mean‐variance pair of the terminal wealth, the revised policy enables the investor to receive a free cash flow stream (FCFS) during the investment process. The analytical expressions of the probability of receiving FCFS and the expected value of FCFS are derived.
  • Publisher: Malden, USA: Blackwell Publishing Inc
  • Language: English
  • Identifier: ISSN: 0960-1627
    EISSN: 1467-9965
    DOI: 10.1111/j.1467-9965.2010.00461.x
  • Source: Alma/SFX Local Collection
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