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arXiv · 1907.11378

Time-inconsistency with rough volatility

Bingyan Han·Hoi Ying Wong
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Abstract

In this paper, we consider equilibrium strategies under Volterra processes and time-inconsistent preferences embracing mean-variance portfolio selection (MVP). Using a functional It\^o calculus approach, we overcome the non-Markovian and non-semimartingale difficulty in Volterra processes. The equilibrium strategy is then characterized by an extended path-dependent Hamilton-Jacobi-Bellman equation system under a game-theoretic framework. A verification theorem is provided. We derive explicit solutions to three problems, including MVP with constant risk aversion, MVP for log returns, and a mean-variance objective with a linear controlled Volterra process. We also thoroughly examine the effect of volatility roughness on equilibrium strategies. Numerical experiments demonstrate that trading rules with rough volatility outperform the classic counterparts.

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Bingyan Han, Hoi Ying Wong. 2019-07-26. Time-inconsistency with rough volatility. https://doi.org/10.1137/20m136654x

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