A Primal-Dual Decomposition-Based Interior-Point Approach to Two-Stage Stochastic Programming

Arjan B. Berkelaar (), K. P. Bart Oldenkamp () and Cees L. Dert ()
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Arjan B. Berkelaar: Erasmus University
K. P. Bart Oldenkamp: Erasmus University
Cees L. Dert: Free University of Amsterdam

No 151, Computing in Economics and Finance 1999 from Society for Computational Economics

Abstract: Decision making under uncertainty is a challenge faced by many decision makers. Stochastic programming is a major tool developed to deal with optimization with uncertainties that has found applications in finance such as asset-liability and bond-portfolio management. Computationally however, many models in stochastic programming remain unsolvable because of overwhelming dimensionality. For a model to be well solvable, its special structure must be explored. Most of the solution methods are based on decomposing the data. In this paper we propose a new decomposition approach for two-stage stochastic programming, based on a direct application of the path-following method combined with the homogeneous self-dual technique. Numerical experiments show that our decomposition algorithm performs better than other methods for stochastic programming. We apply our decomposition method to a two-period portfolio selection problem using options on a stock index. In this model the investor can invest in a money-market account, a stock index, and European options on this index with two different maturities. The investor can revise his portfolio holdings at the expiration of those options with shortest maturity. We use real data from the Dutch AEX index.

Date: 1999-03-01
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