The Markov Chain Approximation Approach for Numerical Solution of Stochastic Control Problems: Experiences from Merton's Problem

Claus Munk

Finance from University Library of Munich, Germany

Abstract: Many problems in modern financial economics involve the solution of continuous-time, continuous-state stochastic control problems. Since explicit solutions of such problems are extremely rare, efficient numerical methods are called for. The Markov chain approximation approach provides a class of methods that are simple to understand and implement. In this paper, we compare the performance of different variations of the approach on a problem with a well-known solution, namely Merton's consumption/portfolio problem. We suggest a variant of the method, which outperforms the known variants, at least when applied to this specific problem. We document that the size of the contraction parameter of the control problem is of great importance for the accuracy of the numerical results. We also demonstrate that the Richardson extrapolation technique can improce accuracy significantly.

Keywords: Stochastic control; efficient numerical solution; Merton's consumption/portfolio problem (search for similar items in EconPapers)
JEL-codes: C61 G11 (search for similar items in EconPapers)
Pages: 31 pages
Date: 1998-02-11
New Economics Papers: this item is included in nep-fmk
Note: Type of Document - Latex 2e; prepared on PC; to print on PostScript; pages: 31 ; figures: included
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

Downloads: (external link)
https://econwpa.ub.uni-muenchen.de/econ-wp/fin/papers/9802/9802002.pdf (application/pdf)
https://econwpa.ub.uni-muenchen.de/econ-wp/fin/papers/9802/9802002.ps.gz (application/postscript)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:wpa:wuwpfi:9802002

Access Statistics for this paper

More papers in Finance from University Library of Munich, Germany
Bibliographic data for series maintained by EconWPA ( this e-mail address is bad, please contact ).