TY  - JOUR
AU  - Aït-Sahalia,Yacine
AU  - Brandt,Michael W.
TI  - Consumption and Portfolio Choice with Option-Implied State Prices
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 13854
PY  - 2008
Y2  - March 2008
UR  - http://www.nber.org/papers/w13854
L1  - http://www.nber.org/papers/w13854.pdf
N1  - Author contact info:
Yacine Ait-Sahalia
Department of Economics
Fisher Hall
Princeton University
Princeton, NJ 08544-1021
Tel: 609/258-4015
Fax: 609/258-0719
E-Mail: yacine@princeton.edu

Michael W. Brandt
Fuqua School of Business
Duke University
One Towerview Drive
Durham, NC  27708
Tel: 919/660-1948
Fax: 919/660-8038
E-Mail: mbrandt@duke.edu
AB  - We propose an empirical implementation of the consumption-investment problem using the martingale representation alternative to dynamic programming. Our method is based on the direct observation of state prices from options data.  This greatly simplifies the investor's task of specifying the investment opportunity set and inherits the computational convenience of the martingale representation. Our method also makes explicit the economic trade-off between exploiting differences in state prices and probabilities, which generate variation in consumption, and the consumption smoothing induced by risk aversion. Using options-implied information, we find quantitatively different optimal consumption and portfolio policies than those implied by standard return dynamics.
ER  -