Abstract.
This paper develops a continuous time portfolio optimization model where the mean returns of individual securities or asset categories are explicitly affected by underlying economic factors such as dividend yields, a firm's return on equity, interest rates, and unemployment rates. In particular, the factors are Gaussian processes, and the drift coefficients for the securities are affine functions of these factors. We employ methods of risk-sensitive control theory, thereby using an infinite horizon objective that is natural and features the long run expected growth rate, the asymptotic variance, and a single risk-aversion parameter. Even with constraints on the admissible trading strategies, it is shown that the optimal trading strategy has a simple characterization in terms of the factor levels. For particular factor levels, the optimal trading positions can be obtained as the solution of a quadratic program. The optimal objective value, as a function of the risk-aversion parameter, is shown to be the solution of a partial differential equation. A simple asset allocation example, featuring a Vasicek-type interest rate which affects a stock index and also serves as a second investment opportunity, provides some additional insight about the risk-sensitive criterion in the context of dynamic asset management.
Article PDF
Avoid common mistakes on your manuscript.
Author information
Authors and Affiliations
Additional information
Accepted 10 December 1997
Rights and permissions
About this article
Cite this article
Bielecki, T., Pliska, S. Risk-Sensitive Dynamic Asset Management. Appl Math Optim 39, 337–360 (1999). https://doi.org/10.1007/s002459900110
Issue Date:
DOI: https://doi.org/10.1007/s002459900110