A note on the integrability of the classical portfolio selection model

We revisit the classical Merton portfolio selection model from the perspective of integrability analysis. By an application of a nonlocal transformation the nonlinear partial differential equation for the two-asset model is mapped into a linear option valuation equation with a consumption dependent source term. This result is identical to the one obtained by Cox-Huang [J.C. Cox, C.-f. Huang, Optimal consumption and portfolio policies when asset prices follow a diffusion process, J. Econom. Theory 49 (1989) 33-88], using measure theory and stochastic integrals. The nonlinear two-asset equation is then analyzed using the theory of Lie symmetry groups. We show that the linearization is directly related to the structure of the generalized symmetries. © 2010 Elsevier Ltd. All rights reserved.