Time-inconsistency with rough volatility (1907.11378v3)

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.