Optimal tracking portfolio with a ratcheting capital benchmark

DOI10.1137/20M1348856zbMATH Open1468.91133arXiv2006.13661MaRDI QIDQ5000625FDOQ5000625

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Publication date: 15 July 2021

Published in: SIAM Journal on Control and Optimization (Search for Journal in Brave)

Abstract: This paper studies the finite horizon portfolio management by optimally tracking a ratcheting capital benchmark process. It is assumed that the fund manager can dynamically inject capital into the portfolio account such that the total capital dominates a non-decreasing benchmark floor process at each intermediate time. The tracking problem is formulated to minimize the cost of accumulated capital injection. We first transform the original problem with floor constraints into an unconstrained control problem, however, under a running maximum cost. By identifying a controlled state process with reflection, the problem is further shown to be equivalent to an auxiliary problem, which leads to a nonlinear Hamilton-Jacobi-Bellman (HJB) equation with a Neumann boundary condition. By employing the dual transform, the probabilistic representation and some stochastic flow analysis, the existence of the unique classical solution to the HJB equation is established. The verification theorem is carefully proved, which gives the complete characterization of the feedback optimal portfolio. The application to market index tracking is also discussed when the index process is modeled by a geometric Brownian motion.

Full work available at URL: https://arxiv.org/abs/2006.13661

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zbMATH Keywords

probabilistic representationoptimal trackingnondecreasing capital benchmarkrunning maximum coststochastic flow analysis

Mathematics Subject Classification ID

Applications of Brownian motions and diffusion theory (population genetics, absorption problems, etc.) (60J70) Portfolio theory (91G10) Optimal stochastic control (93E20)

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Cited In (9)

• Across-time risk-aware strategies for outperforming a benchmark
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• Centralized systemic risk control in the interbank system: weak formulation and gamma-convergence
• Optimal active lifetime investment
• Optimal consumption with loss aversion and reference to past spending maximum
• A discrete-time benchmark tracking problem in two markets subject to random environments
• Beating a Benchmark: Dynamic Programming May Not Be the Right Numerical Approach

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