Abstract
We study an optimal investment problem for an investor who faces a dynamic risk constraint in a Markovian regime-switching environment. The goal of the investor is to maximize the expected utility of terminal wealth subject to the dynamic risk constraint specified by a proportional Value at Risk (VaR). By transforming the stochastic optimal control problem associated with the optimal investment problem into a deterministic control problem, we obtain a closed-form solution to the optimal investment problem for the case of a power utility. To evaluate the value function, we employ a numerical approximation method based on a piecewise constant approximation to the modulating Markov chain. A numerical example is given to illustrate the impact of the dynamic risk constraint on the optimal investment strategy.
| Original language | English |
|---|---|
| Pages (from-to) | 269-276 |
| Number of pages | 8 |
| Journal | Risk and Decision Analysis |
| Volume | 3 |
| Issue number | 4 |
| DOIs | |
| Publication status | Published - 17 Dec 2012 |
Keywords
- dynamic risk constraint
- martingale transform
- Optimal portfolio selection
- piecewise constant approximation
- power utility
- regime switching
ASJC Scopus subject areas
- Economics and Econometrics
- Finance
- Statistics, Probability and Uncertainty
- Statistics and Probability