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A Stochastic Flows Approach for Asset Allocation with Hidden Economic Environment

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  • Tak Kuen Siu

Abstract

An optimal asset allocation problem for a quite general class of utility functions is discussed in a simple two-state Markovian regime-switching model, where the appreciation rate of a risky share changes over time according to the state of a hidden economy. As usual, standard filtering theory is used to transform a financial model with hidden information into one with complete information, where a martingale approach is applied to discuss the optimal asset allocation problem. Using a martingale representation coupled with stochastic flows of diffeomorphisms for the filtering equation, the integrand in the martingale representation is identified which gives rise to an optimal portfolio strategy under some differentiability conditions.

Suggested Citation

  • Tak Kuen Siu, 2015. "A Stochastic Flows Approach for Asset Allocation with Hidden Economic Environment," International Journal of Stochastic Analysis, Hindawi, vol. 2015, pages 1-11, January.
    • Handle: RePEc:hin:jnijsa:462524
    DOI: 10.1155/2015/462524
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    Cited by:

    1. Wei-han Liu, 2023. "Attaining stochastic optimal control over debt ratios in U.S. markets," Review of Quantitative Finance and Accounting, Springer, vol. 61(3), pages 967-993, October.
    2. Robert J. Elliott & Tak Kuen Siu, 2023. "Hedging options in a hidden Markov‐switching local‐volatility model via stochastic flows and a Monte‐Carlo method," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 43(7), pages 925-950, July.

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