Solving the Non-Linear Dynamic Asset Allocation Problem: Effects of Arbitrary Stochastic Processes and Unsystematic Risk on the Super Efficient Portfolio Space
In this paper we propose a methodology that we believe improves the effectiveness of several common assumptions underlying Modern Portfolio Theory's dynamic optimization framework. The paper derives a general outline of a stochastic nonlinear-quadratic control for analyzing and solving a non-linear mean-variance optimization problem. The study first develops and then investigates the role of unsystematic (credit) risk in this continuous time stochastic asset allocation model where the wealth generating process has a non-negative constraint. The paper finds that given unsystematic risk, wealth constraints and higher order moments the market price of risk is non-constant and the investor's optimal terminal return may be lower than previously indicated by a number of classical models. This result provides a convenient solution to practitioners seeking to evaluate competing investment strategies.
|Date of creation:||Jan 2009|
|Contact details of provider:|| Postal: University of Connecticut 365 Fairfield Way, Unit 1063 Storrs, CT 06269-1063|
Phone: (860) 486-4889
Fax: (860) 486-4463
Web page: http://www.econ.uconn.edu/
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Jondeau, Eric & Rockinger, Michael, 2001. "Gram-Charlier densities," Journal of Economic Dynamics and Control, Elsevier, vol. 25(10), pages 1457-1483, October.
- Francis A. Longstaff & Sanjay Mithal & Eric Neis, 2005.
"Corporate Yield Spreads: Default Risk or Liquidity? New Evidence from the Credit Default Swap Market,"
Journal of Finance,
American Finance Association, vol. 60(5), pages 2213-2253, October.
- Francis A. Longstaff & Sanjay Mithal & Eric Neis, 2004. "Corporate Yield Spreads: Default Risk or Liquidity? New Evidence from the Credit-Default Swap Market," NBER Working Papers 10418, National Bureau of Economic Research, Inc.
- Longstaff, Francis A, 1995. "Option Pricing and the Martingale Restriction," Review of Financial Studies, Society for Financial Studies, vol. 8(4), pages 1091-1124.
- Robert JARROW & Andrew RUDD, 2008. "Approximate Option Valuation For Arbitrary Stochastic Processes," World Scientific Book Chapters,in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 1, pages 9-31 World Scientific Publishing Co. Pte. Ltd..
- Jarrow, Robert & Rudd, Andrew, 1982. "Approximate option valuation for arbitrary stochastic processes," Journal of Financial Economics, Elsevier, vol. 10(3), pages 347-369, November.
- Kwamie Dunbar, 2009. "The Effects of Credit Risk on Dynamic Portfolio Management: A New Computational Approach," Working papers 2009-03, University of Connecticut, Department of Economics, revised Feb 2009.
- Hakansson, Nils H, 1970. "Optimal Investment and Consumption Strategies Under Risk for a Class of Utility Functions," Econometrica, Econometric Society, vol. 38(5), pages 587-607, September.
- Bawa, Vijay S. & Lindenberg, Eric B., 1977. "Capital market equilibrium in a mean-lower partial moment framework," Journal of Financial Economics, Elsevier, vol. 5(2), pages 189-200, November.
- Stapleton, R C & Subrahmanyam, M G, 1983. " The Market Model and Capital Asset Pricing Theory: A Note," Journal of Finance, American Finance Association, vol. 38(5), pages 1637-1642, December. Full references (including those not matched with items on IDEAS)
When requesting a correction, please mention this item's handle: RePEc:uct:uconnp:2009-04. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Mark McConnel)
If references are entirely missing, you can add them using this form.