Scandinavian Working Papers in Economics

Working Papers,
Lund University, Department of Economics

No 2005:17: Expected Life-Time Utility and Hedging Demands in a Partially Observable Economy

Frederik Lundtofte ()
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Frederik Lundtofte: Department of Economics, Lund University, Postal: Department of Economics, School of Economics and Management, Lund University, Box 7082, S-220 07 Lund, Sweden

Abstract: This paper analyzes the expected life-time utility and the hedging demands in a Lucas (1978) economy, in which the dividend drift term is unknown and mean-reverting. An expression for the individual investor’s expected life-time utility in equilibrium is derived, and his hedging demand is analyzed. The hedging demand consists of two components, which could work in opposite directions so that a conservative investor may end up having a positive hedging demand. Interestingly, this differs from the theoretical findings in Brennan (1998), who analyzes the portfolio choice problem of an agent who learns about a constant expected stock return.

Keywords: learning; incomplete information; equilibrium; hedging demands

JEL-codes: C13; G11; G12

29 pages, February 24, 2005

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