Elasticity approach to portfolio optimization

Holger Kraft ()

Mathematical Methods of Operations Research, 2003, vol. 58, issue 1, 159-182

Abstract: We study investment problems in a continuous-time setting and conclude that the proper control variables are elasticities to the traded assets or, in the case of stochastic interest rates, (factor) durations. This formulation of a portfolio problem allows us to solve the problems in a kind of two-step procedure: First, by calculating the optimal elasticities and durations we determine the optimal wealth process and then we compute a portfolio process which tracks these elasticities and durations. Our findings are not only interesting in itself, but the approach also proves useful in many varied applications including portfolios with (path-dependent) options. An important application can be the solution of portfolio problems with defaultable bonds modelled by a firm value approach. Copyright Springer-Verlag 2003

Keywords: Optimal portfolios; Elasticity; Derivatives; Stochastic interest rates; Duration; G11; 93E20 (search for similar items in EconPapers)
Date: 2003
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DOI: 10.1007/s001860300296

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