We empirically study the economic benefits of giving investors access to index options in the standard portfolio problem, analyzing both expected-utility and nonexpected-utility investors in order to understand who optimally buys and sells options. Using data on S&P 500 index options, CRRA investors find it always optimal to short out-of-the-money puts and at-the-money straddles. The option positions are economically and statistically significant and robust to corrections for transaction costs, margin requirements, and Peso problems. Loss-averse and disappointment-averse investors also optimally hold short option positions. Only with highly distorted probability assessments can we obtain positive portfolio weights for puts (cumulative prospect theory and anticipated utility) and straddles (anticipated utility).

This paper solves numerically the intertemporal consumption and portfolio choice problem of an infinitely-lived investor who faces a time-varying equity premium. The solutions we obtain are very similar to the approximate analytical solutions of Campbell and Viceira (1999), except at the upper extreme of the state space where both the numerical consumption and portfolio rules flatten out. We also consider a constrained version of the problem in which the investor faces borrowing and short-sales restrictions. These constraints bind when the equity premium moves away from its mean in either direction, and are particularly severe for risk-tolerant investors. The constraints have substantial effects on optimal consumption, but much more modest effects on optimal portfolio choice in the region of the state space where they are not binding.