A dynamic programming approach to path-dependent constrained portfolios

Marcos Escobar-Anel ()
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Marcos Escobar-Anel: University of Western Ontario
Authors registered in the RePEc Author Service: Marcos Escobar Anel ()

Annals of Operations Research, 2022, vol. 315, issue 1, No 7, 157 pages

Abstract: Abstract This paper introduces a methodology to produce analytical solutions to an expected utility optimization problem with path-dependent constraints on wealth. This is achieved via a combination of dynamic programming and financial derivatives. The paper focuses on solving the case of a Value at Risk constraint on the running minimum of the wealth process. The optimal wealth is shown to be a barrier-type contingent claim on the unconstrained optimal wealth; the optimal investment strategy and value function follow similarly. A comparison of Value at Risk constraints between terminal wealth and the running minimum of wealth demonstrates a difference of up to 30% on risky asset allocation. Other meaningful examples of interest for investment managers are briefly described.

Keywords: Expected utility theory; Constrained portfolio optimization; Path-dependent claims; Barrier derivatives (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1007/s10479-022-04640-4

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