Optimal portfolio for a defined-contribution pension plan under a constant elasticity of variance model with exponential utility

Abstract

Based on the Lie symmetry method, we derive the explicit optimal invest strategy for an investor who seeks to maximize the expected exponential (CARA) utility of the terminal wealth in a defined-contribution pension plan under a constant elasticity of variance model. We examine the point symmetries of the Hamilton-Jacobi-Bellman (HJB) equation associated with the portfolio optimization problem. The symmetries compatible with the terminal condition enable us to transform the (2+ 1)-dimensional HJB equation into a (1+ 1)-dimensional nonlinear equation which is linearized by its infinite-parameter Lie group of point transformations. Finally, the ansatz technique based on variables separation is applied to solve the linear equation and the optimal strategy is obtained. The algorithmic procedure of the Lie symmetry analysis method adopted here is quite general compared with conjectures used in the literature.

Keywords

Lie symmetry / portfolio / defined-contribution (DC) pension plan / constant elasticity of variance (CEV) model / exponential utility

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