On Optimal Portfolio Choice Under Stochastic Interest Rates
Using the martingale approach, the optimal strategy of an expected utility maximizer is shown to include, in addition to the traditional pure hedge and speculative components, only two Merton-Breeden-type hedging elements instead of K hedging elements associated with the (potentially numerous) K state variables driving the investment opportunity set. The first one is associated with interest rate risk and the second one with the risk brought about by co-movements of the spot interest rate and market prices of risk.
LIOUI, A. et PONCET, P. (2001). On Optimal Portfolio Choice Under Stochastic Interest Rates. Journal of Economic Dynamics and Control, pp. 1841-1865.