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RFS Advance Access originally published online on May 15, 2006
Review of Financial Studies 2007 20(1):1-39; doi:10.1093/rfs/hhl001
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© The Author 2006. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For permissions, please email: journals.permissions@oxfordjournals.org.

Portfolio Selection in Stochastic Environments

Jun Liu
University of California, San Diego

Address correspondence to Jun Liu, The Rady School of Management, UCSD, 9500 Gilman Dr, MC 0093, Pepper Canyon Hall, Room 320, San Diego, CA 92130-0093, or e-mail: junliu{at}ucsd.edu

In this article, I explicitly solve dynamic portfolio choice problems, up to the solution of an ordinary differential equation (ODE), when the asset returns are quadratic and the agent has a constant relative risk aversion (CRRA) coefficient. My solution includes as special cases many existing explicit solutions of dynamic portfolio choice problems. I also present three applications that are not in the literature. Application 1 is the bond portfolio selection problem when bond returns are described by "quadratic term structure models." Application 2 is the stock portfolio selection problem when stock return volatility is stochastic as in Heston model. Application 3 is a bond and stock portfolio selection problem when the interest rate is stochastic and stock returns display stochastic volatility. (JEL G11)


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