A MARKOVIAN APPROXIMATED SOLUTION TO A PORTFOLIO MANAGEMENT PROBLEM



Constraints. The constraints have to be dealt
with “manually”. The local instantaneous con-
straints on controls
uι(t) and U2{t) (27) can be
immediately expressed in discrete time as

θ ≤ uι,e ≤ ɪ, and C2,./ ≥ 0.     (33)

The portfolio admissibility condition, which in the
continuous version amounts to
x(t) ≥ 0, Vt ∈
[0,T], [4], cannot however be directly replaced by
X( ≥ 0. This is (mainly) because X( is expressible
in terms of uɪ,/-i and C2,/-ɪ yet we need a
condition valid for time
I. It appears (from [10] )
that the best discrete-time counterpart of
x{t) ≥ 0
is

X((1 + δ(r + uιrt(a — r))) — δU2rι ≥ 0   (34)

where δ is the time discretisation step (see Section
2.2). It has to be borne in mind that (34) is
an
approximation to the portfolio admissibility
condition and that it depends on the time dis-
cretisation step.

Technical hints. A cautionary remark about
numerical optimisation is in place. Most optimi-
sation methods work (much) more efficiently if
the solution vector components are of comparable
magnitudes. This is not the case of the control
variables uɪ and C2. Indeed, uɪ is bounded be-
tween 0 and 1 but,
U2 is practically unbounded
from above, see Figure 2. This caused some (not
insuperable) difficulties in [6] in obtaining accu-
rate approximating solutions. In this paper, such
difficulties were avoided through
re-scaling of the
model. It follows from (32) that
U2 (t) is linear in
the state
x{t). All U2{t) were then replaced by
u2(t)x(t) in the optimisation problem max (28)
subject to (26). Consequently, the numerical rou-
tines were looking for u2(t) that was not greater
than 12 for most of the cases solved. Moreover,
because of the above transformation the strategy
graphs will no longer be linear as in Figure 2 low
panel but horizontal (as in Figure 7).

Important software control parameters are the
time discretisation step
δ and the state space
grid width
h. To get an idea of their range val-
ues, necessary for an accurate approximation, a
deterministic portfolio control problem (T = 2)
was solved: first analytically, then, the discretised
model solutions were computed. Figure 5 shows
the results.

The plot coordinates are the time discretisation
step
δ and a utility measure. The horizon is T = 2;
the remaining model parameters are as in Section
4.1.

Discrete ModelUtility Measures(T=2)

500

480

460

440

<-continUous time model optimal Utility"

420

h=500        :

t h=500

400


h=20Q00'


+ h=20000


t h=20000

380
0          02         04         0.6         0.8          1          1.2         14         1.6

6

Fig. 5. Discretised model utility realisations.

The point denoted “*” (0,422) is the continuous
model optimal utility. The
discrete time model
utility values converge toward this point as <) → O.
Notice that they are greater than the continuous
model utility. This is because (in the rectangular
method) the integration error grows in
δ. The
points denoted “+” correspond to utility reali-
sations of a model discretised both in time and
space (Markov chain). It is clear from the figure
that reasonable utility approximations can only
be obtained for
δ < .1 and h < 500.

The impact of the length of the time step δ on the
solution accuracy in a stochastic model is shown
in Figure 6.

Consider time I {l = 0,1...N — 1) and r( to be
applied at this time. Assuming that the choice of
U2rι is made optimal

ι∕ = arg max


^δγ∕U2rι + e βig(l + <5)Eλ∕x∕+5^

= arg max (Eλ∕x∕+⅛) ,         (35)

see (29). The expected value in (35) was computed
using a Taylor series (second order) expansion and
presented as a function of strategy uɪ in Figure 6.
The strategy domain was “extended” beyond the
feasible range [0 1] to show the utility measure
shapes. Notice that, for the feasible uɪ ∈ [0, 1],
the utility measures would all look flat.



More intriguing information

1. El Mercosur y la integración económica global
2. Language discrimination by human newborns and by cotton-top tamarin monkeys
3. The name is absent
4. The bank lending channel of monetary policy: identification and estimation using Portuguese micro bank data
5. THE DIGITAL DIVIDE: COMPUTER USE, BASIC SKILLS AND EMPLOYMENT
6. How to do things without words: Infants, utterance-activity and distributed cognition.
7. The name is absent
8. The name is absent
9. The name is absent
10. Modelling the health related benefits of environmental policies - a CGE analysis for the eu countries with gem-e3
11. The name is absent
12. Review of “The Hesitant Hand: Taming Self-Interest in the History of Economic Ideas”
13. Strategic Planning on the Local Level As a Factor of Rural Development in the Republic of Serbia
14. The Complexity Era in Economics
15. The Role of Land Retirement Programs for Management of Water Resources
16. PROJECTED COSTS FOR SELECTED LOUISIANA VEGETABLE CROPS - 1997 SEASON
17. The name is absent
18. BILL 187 - THE AGRICULTURAL EMPLOYEES PROTECTION ACT: A SPECIAL REPORT
19. Urban Green Space Policies: Performance and Success Conditions in European Cities
20. Why unwinding preferences is not the same as liberalisation: the case of sugar