Dynamic mean–variance problem with frictions

Alain Bensoussan (), Guiyuan Ma (), Chi Chung Siu () and Sheung Chi Phillip Yam ()
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Alain Bensoussan: University of Texas at Dallas
Guiyuan Ma: Xi’an Jiaotong University
Chi Chung Siu: The Hang Seng University of Hong Kong
Sheung Chi Phillip Yam: The Chinese University of Hong Kong

Finance and Stochastics, 2022, vol. 26, issue 2, No 4, 267-300

Abstract: Abstract We study a dynamic mean–variance portfolio selection problem with return predictability and trading frictions from price impact. Applying mean-field type control theory, we provide a characterisation of an equilibrium trading strategy for an investor facing stochastic investment opportunities. An explicit equilibrium strategy is derived in terms of the solution to a generalised matrix Riccati differential equation, and a sufficient condition is also provided to ensure the latter’s well-posedness. Our solution indicates that the investor should trade gradually towards a target portfolio which accounts for return predictability, price impact and time-consistency. Moreover, an asymptotic analysis around small liquidity costs shows that the investor’s target portfolio is an equilibrium portfolio without price impact in the first-order sense, and that her first-order approximated value function does not deteriorate significantly for sufficiently small liquidity costs. Finally, our numerical results demonstrate that the target portfolio is more conservative than an equilibrium portfolio without price impact.

Keywords: Dynamic mean–variance problem; Price impact; Time-inconsistency; Asymptotics; Mean-field type control problems; 91G10; 91G60; 91G80 (search for similar items in EconPapers)
JEL-codes: G11 G21 G24 (search for similar items in EconPapers)
Date: 2022
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Citations: View citations in EconPapers (1)

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DOI: 10.1007/s00780-022-00474-x

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