Abstract
This research aims to find an optimal solution for dynamic portfolio in finite-time horizon under defaultable assets, which means that the assets has a chance to be liquidated in a finite time horizon, e.g corporate bond. Besides investing on those assets, investors will also have benefit in the form of consumption. As a reference in making investment decisions the concept of utility functions and volatility will play a role. Optimal portfolio composition will be obtained by maximizing the total expected discounted utility of consumption in the time span during the investment is executed and also to minimize the risk, the volatility of the investment. Further the reduced form model is applied since the assets prices can be linked with the market risk and the credit risk. The interest rate and the rate of inflation will be allowed as a representation of market risk, while the credit spread will be used as a representation of credit risk. The dynamic of asset prices can be derived analytically by using Ito Calculus in the form of the movement of the three risk factors above. Furthermore, this problem will be solved using the stochastic dynamic programming method by assuming that market is incomplete. Depending on the chosen utility function, the optimal solution of the portfolio composition and the consumption can be found explicitly in the form of feedback control. This is possible since the dynamic of the wealth process of the control variable is linear. To apply dynamic programming as well as to find solutions we use Backward Stochastic Differential Equation (BSDE) where the solution can be solved explicitly, especially where the terminal value of the investment target is chosen random. Further, it will be modeled with Monte Carlo simulation and, calibrated using Indonesia data of stock and corporate bond.
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Acknowledgement
This paper gives a preliminary part of our research. This work has been presented and defensed at the colloquium at Padjadjaran University Bandung Indonesia in December 2013 and at the 9th MRC’s Doctoral Journey of Management colloqium event at University of Indonesia, April 2014. To that, the authors would like to thank for both institutions for having read and reviewed our work.
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Nora Amelda Rizal is currently a PhD Candidate from School of Business Management at Bandung Institut of Technology Indonesia. She is also a lecturer in Telkom University, Indonesia. Her research interests are Quantitative Finance and Corporate Finance.
Sudarso Kaderi Wiryono is a Professor in Business Risk and Finance at School of Business and Management, Bandung Institut of Technology. His research interests are Financial Management, Islamic Banking and Financial System, Corporate Risk Management, and Business Risk and Venture Capital.
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Rizal, N., Wiryono, S. A Literature Review: Modelling Dynamic Portfolio Strategy under Defaultable Assets with Stochastic Rate of Return, Rate of Inflation and Credit Spread Rate. GSTF J Bus Rev 4, 22 (2015). https://doi.org/10.7603/s40706-015-0022-5
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DOI: https://doi.org/10.7603/s40706-015-0022-5