Portfolio Selection with Mandatory Bequest

Abstract

In this paper, optimal consumption and investment decisions are studied for an investor who can invest in a fixed interest rate bank account and a stock whose price is a log normal diffusion. We present the method of the HJB equation in order to explicitly solve problems of this type with modifications such as a fixed percentage transaction cost and a mandatory bequest function. It is shown that the investor treats the mandatory bequest as an expense that she factors into her personal wealth when making consumption and transaction decisions. Furthermore, the investor keeps her portfolio proportions inside a fixed boundary relating to Merton's optimal proportion and the transaction costs.