Portfolio optimization with Markov-modulated stock prices and interest rates

Author

Bäuerle, Nicole ; Rieder, Ulrich

Author_Institution

Abt. fur Math. VII, Univ. Ulm, Germany

Volume

49

Issue

3

fYear

2004

fDate

3/1/2004 12:00:00 AM

Firstpage

442

Lastpage

447

Abstract

A financial market with one bond and one stock is considered where the risk free interest rate, the appreciation rate of the stock and the volatility of the stock depend on an external finite state Markov chain. We investigate the problem of maximizing the expected utility from terminal wealth and solve it by stochastic control methods for different utility functions. Due to explicit solutions it is possible to compare the value function of the problem to one where we have constant (average) market data. The case of benchmark optimization is also considered.

Keywords

Markov processes; economic indicators; investment; optimisation; stock markets; Markov-modulated stock prices; benchmark optimization; bond; financial market; finite-state Markov chain; market data; portfolio optimization; risk free interest rates; stochastic control; stock appreciation rate; stock volatility; terminal wealth; utility functions; Bonding; Diffusion processes; Economic indicators; Investments; Mathematical model; Optimization methods; Portfolios; Stochastic processes;

fLanguage

English

Journal_Title

Automatic Control, IEEE Transactions on

Publisher

ieee

ISSN

0018-9286

Type

jour

DOI

10.1109/TAC.2004.824471

Filename

1273643