Faculty of Economics and Business Administration Publications Database

Optimal Portfolios and Heston''s Stochastic Volatility Model: An Explicit Solution for Power Utility

Volume: 5
Number: 3
Pages: 303 - 313
ISSN-Print: 1469-7688
Link External Source: Online Version
Year: 2005
Keywords: Optimal Portfolios; Stochastic Volatility; Heston Model
Abstract: Given an investor maximizing utility from terminal wealth with respect to a power utility function, we present a verification result for portfolio problems with stochastic volatility. Applying this result, we solve the portfolio problem for Heston''s stochastic volatility model. We find that only under a specific condition on the model parameters does the problem possess a unique solution leading to a partial equilibrium. Finally, it is demonstrated that the results critically hinge upon the specification of the market price of risk. We conclude that, in applications, one has to be very careful when exogenously specifying the form of the market price of risk.