Byung Hwa Lim

Endogenous Credit Constraints and Household Portfolio Choices

We study a continuous-time model of consumption and portfolio selection with limited commitment in a stochastic environment. The credit constraints of a household are determined endogenously in the credit market where creditors know that the household is not committed to payment of debt. By using a duality approach, we transform the problem into a dual minimization problem and subsequently into optimal stopping problems. We derive the time-varying endogenous credit limit and optimal consumption and investment strategies in closed form. We show that the credit limit is cyclical: it is lower (higher) when the Sharpe ratio of the risky asset is high (low). We find that a change in the credit limit and the counter-cyclical Sharpe ratio generate a heterogeneous investment pattern: the rich tend to increase the proportion of risky investment in downturns whereas the poor decrease it, a finding supported by the Survey of Consumer Finance data.

Robust Consumption and Portfolio Rules with Time-Varying Model Confidence

This paper investigates robust optimal consumption and portfolio rules for an Epstein-Zin type investor who is concerned about model misspecification. We propose a semi-explicit solution for the generalized problem of [Hansen, L., Sargent, T., 2001. Robust control and model uncertainty. The American Economic Review 91 (2), 60–66.]. Numerical results show that the optimal behaviors change dramatically according to the investor’s confidence level on the estimated model and that the elasticity of intertemporal substitution in consumption can affect investment ratio. In addition, we show how the investor decides her optimal behaviors for the worst-case scenario.

Optimal Consumption and Investment under Time-Varying Liquidity Constraints

We study consumption and investment decisions given realistic time-varying constraints on borrowing. We first consider the case where borrowing is constrained by a maximum debt-to-income ratio. We then consider collateral borrowing with a maximum loan-to-value ratio. The resulting implications for optimal policies differ considerably from those obtained in the existing literature based on fixed borrowing limits but are consistent with those documented in the empirical literature.

Optimal Bankruptcy with a Continuous Debt Repayment

We investigate the optimal consumption and investment problem when a working debtor has an option to file for bankruptcy. By applying the duality approach, the closed-form solutions are obtained for the case of CRRA utility function. The optimal bankruptcy time is determined by the first hitting time when the financial wealth hits the wealth threshold derived from the optimal stopping time problem. Moreover, the numerical results show that the investment increases as the wealth approaches the threshold and the value gain from the bankruptcy option is vanished as wealth increases.

A Risk-Averse Insider and Asset Pricing in Continuous Time

This paper derives an equilibrium asset price when there exist three kinds of traders in financial market: a risk-averse informed trader, noise traders, and risk neutral market makers. This paper is an extended version of Kyle’s (1985, Econometrica) continuous time model by introducing insider’s risk aversion. We obtain not only the equilibrium asset pricing and market depth parameter but also insider’s value function and optimal insider’s trading strategy explicitly. The comparative static shows that the market depth (the reciprocal of market pressure) increases with time and volatility of noise traders’ trading.

Optimal Asset Allocation with Minimum Performance and Inflation Risk

Abstract We investigate the dynamic asset allocation problem under infla tion risk when the wealth of an investor is con-strained with minimum requirements. To capture the investor’s r isk preference, the CRRA utility function is considered and he maximizes his expected utility at predetermined date of the refund by participation in the financial market. The financial market is supposed to consist of three kinds of financial instruments which are a risk free asset, a risky asset, and an index bond. The role of an index bond is managing inflation risk represented by price process. The optimal wealth and the optimal asset allocation are derived explicitly by using the method to get the European call option pricing formula. From the numerical results, it is confirmed that the investments on index bond is high when the investor’s wealth level is low. However, as his wealth increases, the investments on index bond decreases and he invests on risky asset more. Furthermore, the minimum we alth constraint induces lower investment on risky asset but the effect of the constraints is reduced as the wealth level increases.

A Lattice Method for Lookback Options with Regime-Switching Volatility

We develop a lattice method for pricing lookback options in a regime-switching market environment. We assume the market is governed by a two-state Markov chain and stock volatility can change whenever the market environment changes. We develop a method which resolves the bias in the binomial method of Babbs (2000), and combine it with the pentanomial method of Bollen (1998). Our method can be used for American-style lookback options as well as European-style lookback options and is a simple but efficient way for pricing them compared with the methods currently available. We also analyze the convergence of the proposed method.