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Robust utility maximization under model uncertainty via a penalization approach

Author

Listed:
  • Ivan Guo

    (Monash University [Melbourne])

  • Nicolas Langrené

    (CSIRO - Commonwealth Scientific and Industrial Research Organisation [Canberra])

  • Gregoire Loeper

    (Monash University [Melbourne])

  • Wei Ning

    (Monash University [Melbourne])

Abstract

This paper addresses the problem of utility maximization under uncertain parameters. In contrast with the classical approach, where the parameters of the model evolve freely within a given range, we constrain them via a penalty function. We show that this robust optimization process can be interpreted as a two-player zero-sum stochastic differential game. We prove that the value function satisfies the Dynamic Programming Principle and that it is the unique viscosity solution of an associated Hamilton-Jacobi-Bellman-Isaacs equation. We test this robust algorithm on real market data. The results show that robust portfolios generally have higher expected utilities and are more stable under strong market downturns. To solve for the value function, we derive an analytical solution in the logarithmic utility case and obtain accurate numerical approximations in the general case by three methods: finite difference method, Monte Carlo simulation, and Generative Adversarial Networks.

Suggested Citation

  • Ivan Guo & Nicolas Langrené & Gregoire Loeper & Wei Ning, 2020. "Robust utility maximization under model uncertainty via a penalization approach," Working Papers hal-02910261, HAL.
  • Handle: RePEc:hal:wpaper:hal-02910261
    Note: View the original document on HAL open archive server: https://hal.science/hal-02910261
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    References listed on IDEAS

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    Cited by:

    1. William Lefebvre & Gregoire Loeper & Huy^en Pham, 2020. "Mean-variance portfolio selection with tracking error penalization," Papers 2009.08214, arXiv.org, revised Sep 2020.
    2. Willliam Lefebvre & Gregoire Loeper & Huyên Pham, 2020. "Mean-variance portfolio selection with tracking error penalization," Working Papers hal-02941289, HAL.
    3. Daniel Bartl & Michael Kupper & Ariel Neufeld, 2021. "Duality theory for robust utility maximisation," Finance and Stochastics, Springer, vol. 25(3), pages 469-503, July.
    4. William Lefebvre & Grégoire Loeper & Huyên Pham, 2020. "Mean-Variance Portfolio Selection with Tracking Error Penalization," Mathematics, MDPI, vol. 8(11), pages 1-23, November.
    5. Naudé, Wim, 2023. "Artificial Intelligence and the Economics of Decision-Making," IZA Discussion Papers 16000, Institute of Labor Economics (IZA).

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    More about this item

    Keywords

    robust portfolio optimization; differential games; HJBI equation; Generative adversarial networks; GANs; Monte Carlo;
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