Approximating Large Diversified Portfolios

Norbert Hofmann and Eckhard Platen ()

Mathematical Finance, 2000, vol. 10, issue 1, 77-88

Abstract: This paper considers a financial market with asset price dynamics modeled by a system of lognormal stochastic differential equations. A one‐dimensional stochastic differential equation for the approximate evolution of a large diversified portfolio formed by these assets is derived. This identifies the asymptotic dynamics of the portfolio as being a lognormal diffusion. Consequentially an efficient way for computing probabilities, derivative prices, and other quantities for the portfolio are obtained. Additionally, the asymptotic strong and weak orders of convergence with respect to the number of assets in the portfolio are determined.

Date: 2000
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