Portfolio optimization under dynamic risk constraints: Continuous vs. discrete time trading

Redeker Imke () and Wunderlich Ralf ()
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Redeker Imke: Institute of Mathematics, Brandenburg University of Technology Cottbus–Senftenberg,Postbox 101344, 03013Cottbus, Germany
Wunderlich Ralf: Institute of Mathematics, Brandenburg University of TechnologyCottbus–Senftenberg, Postbox 101344, 03013Cottbus, Germany

Statistics & Risk Modeling, 2018, vol. 35, issue 1-2, 1-21

Abstract: We consider an investor facing a classical portfolio problem of optimal investment in a log-Brownian stock and a fixed-interest bond, but constrained to choose portfolio and consumption strategies that reduce a dynamic shortfall risk measure. For continuous- and discrete-time financial markets we investigate the loss in expected utility of intermediate consumption and terminal wealth caused by imposing a dynamic risk constraint. We derive the dynamic programming equations for the resulting stochastic optimal control problems and solve them numerically. Our numerical results indicate that the loss of portfolio performance is not too large while the risk is notably reduced. We then investigate time discretization effects and find that the loss of portfolio performance resulting from imposing a risk constraint is typically bigger than the loss resulting from infrequent trading.

Keywords: Consumption-investment problem; stochastic optimal control; dynamic risk measure; Markov decision problem; discrete-time approximation (search for similar items in EconPapers)
Date: 2018
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DOI: 10.1515/strm-2017-0001

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