Utility Indifference Pricing: A Time Consistent Approach

Research paper by Traian A Pirvu, Huayue Zhang

Indexed on: 24 Feb '11Published on: 24 Feb '11Published in: Mathematics - Optimization and Control


This paper considers the optimal portfolio selection problem in a dynamic multi-period stochastic framework with regime switching. The risk preferences are of exponential (CARA) type with an absolute coefficient of risk aversion which changes with the regime. The market model is incomplete and there are two risky assets: one tradable and one non-tradable. In this context, the optimal investment strategies are time inconsistent. Consequently, the subgame perfect equilibrium strategies are considered. The utility indifference prices of a contingent claim written on the risky assets are computed via an indifference valuation algorithm. By running numerical experiments, we examine how these prices vary in response to changes in model parameters.