Optimal Consumption and Investment Strategies with Stochastic Interest Rates

Claus Munk, Carsten Sørensen*

*Corresponding author for this work

Research output: Contribution to journalJournal articleResearchpeer-review


We characterize the solution to the consumption and investment problem of a power utility investor in a continuous-time dynamically complete market with stochastic changes in the opportunity set. Under stochastic interest rates the investor optimally hedges against changes in the term structure of interest rates by investing in a coupon bond, or portfolio of bonds, with a payment schedule that equals the forward-expected (i.e. certainty equivalent) consumption pattern. Numerical experiments with two different specifications of the term structure dynamics (the Vasicek model and a three-factor non-Markovian Heath–Jarrow–Morton model) suggest that the hedge portfolio is more sensitive to the form of the term structure than to the dynamics of interest rates.
Original languageEnglish
JournalJournal of Banking & Finance
Issue number8
Pages (from-to)1987-2013
Number of pages27
Publication statusPublished - 2004

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