Viscosity characterization of the value function of an investment-consumption problem in presence of illiquid assets

TL;DR

This paper analyzes an optimal investment and consumption problem involving liquid and illiquid assets, proving the value function's viscosity solution property and developing a numerical method to quantify illiquidity costs.

Contribution

It establishes the viscosity solution characterization of the value function in a mixed discrete/continuous control problem with illiquid assets and introduces a numerical algorithm for approximation.

Findings

Proves the value function is the unique viscosity solution of the HJB equation.

Develops a numerical algorithm to approximate the value function.

Quantifies the cost of illiquidity in the investment model.

Abstract

We study a problem of optimal investment/consumption over an infinite horizon in a market consisting of a liquid and an illiquid asset. The liquid asset is observed and can be traded continuously, while the illiquid one can only be traded and observed at discrete random times corresponding to the jumps of a Poisson process. The problem is a nonstandard mixed discrete/continuous optimal control problem which we face by the dynamic programming approach. The main aim of the paper is to prove that the value function is the unique viscosity solution of an associated HJB equation. We then use such result to build a numerical algorithm allowing to approximate the value function and so to measure the cost of illiquidity.