Expected Life-Time Utility and Hedging Demands in a Partially Observable Economy

This paper analyzes the expected life-time utility and the hedging demands in a Lucas (1978) economy, in which the dividend drift term is unknown and mean-reverting. An expression for the individual investor’s expected life-time utility in equilibrium is derived, and his hedging demand is analyzed. The hedging demand consists of two components, which could work in opposite directions so that a conservative investor may end up having a positive hedging demand. Interestingly, this differs from the theoretical findings in Brennan (1998), who analyzes the portfolio choice problem of an agent who learns about a constant expected stock return.