Asymptotic approximation of optimal portfolio for small time horizons

DOI10.1137/17M1111371zbMATH Open1396.91691arXiv1611.09300OpenAlexW2795570552MaRDI QIDQ4579841FDOQ4579841

Authors: Rohini Kumar, Hussein Nasralah 

Publication date: 10 August 2018

Published in: SIAM Journal on Financial Mathematics (Search for Journal in Brave)

Abstract: We consider the problem of portfolio optimization in a simple incomplete market and under a general utility function. By working with the associated Hamilton-Jacobi-Bellman partial differential equation (HJB PDE), we obtain a closed-form formula for a trading strategy which approximates the optimal trading strategy when the time horizon is small. This strategy is generated by a first order approximation to the value function. The approximate value function is obtained by constructing classical sub- and super-solutions to the HJB PDE using a formal expansion in powers of horizon time. Martingale inequalities are used to sandwich the true value function between the constructed sub- and super-solutions. A rigorous proof of the accuracy of the approximation formulas is given. We end with a heuristic scheme for extending our small-time approximating formulas to approximating formulas in a finite time horizon.

Full work available at URL: https://arxiv.org/abs/1611.09300

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zbMATH Keywords

portfolio optimizationprobabilitystochastic controlquantitative finance

Mathematics Subject Classification ID

Portfolio theory (91G10) Viscosity solutions to Hamilton-Jacobi equations in optimal control and differential games (49L25) Martingales with continuous parameter (60G44) Financial applications of other theories (91G80) Optimal stochastic control (93E20)

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Cited In (3)

• Asymptotic expansion for a Black-Scholes model with small noise stochastic jump-diffusion interest rate
• Analysis of Optimal Portfolio on Finite and Small-Time Horizons for a Stochastic Volatility Market Model
• Analysis of optimal portfolio on finite and small-time horizons for a stochastic volatility model with multiple correlated assets

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