TY - JOUR

T1 - Optimal Policies for Investment with Time-Varying Return Distributions

AU - Donchev, Doncho S.

AU - Rachev, Svetlosar T.

AU - Steigerwald, Douglas G.

N1 - Copyright:
Copyright 2005 Elsevier B.V., All rights reserved.

PY - 2002

Y1 - 2002

N2 - We develop a model in which investors must learn the distribution of asset returns over time. The process of learning is made more difficult by the fact that the distributions are not constant through time. We consider risk-neutral investors who have quadratic utility and are selecting between two risky assets. We determine the time at which it is optimal to update the distribution estimate and hence, alter portfolio weights. Our results deliver an optimal policy for asset allocation, that is, the sequence of time intervals at which it is optimal to switch between assets, based on stochastic optimal control theory. In addition, we determine the time intervals in which asset switching leads to a loss with high probability. We provide estimates of the effectiveness of the optimal policy.

AB - We develop a model in which investors must learn the distribution of asset returns over time. The process of learning is made more difficult by the fact that the distributions are not constant through time. We consider risk-neutral investors who have quadratic utility and are selecting between two risky assets. We determine the time at which it is optimal to update the distribution estimate and hence, alter portfolio weights. Our results deliver an optimal policy for asset allocation, that is, the sequence of time intervals at which it is optimal to switch between assets, based on stochastic optimal control theory. In addition, we determine the time intervals in which asset switching leads to a loss with high probability. We provide estimates of the effectiveness of the optimal policy.

KW - Asset allocation

KW - Optimal policy

KW - Stochastic control

KW - Two-armed Bandit problem

UR - http://www.scopus.com/inward/record.url?scp=0036039434&partnerID=8YFLogxK

U2 - 10.1023/A:1019954626395

DO - 10.1023/A:1019954626395

M3 - Article

AN - SCOPUS:0036039434

VL - 4

SP - 269

EP - 312

JO - Journal of Computational Analysis and Applications

JF - Journal of Computational Analysis and Applications

SN - 1521-1398

IS - 4

ER -