The Impact of Short-Sale Constraints on Asset Allocation Strategies via the Backward Markov Chain Approximation Method

Abstract

This paper considers an asset allocation strategy over a finite period under investment uncertainty and short-sale constraints as a continuoustime stochastic control problem. Investment uncertainty is characterised by a stochastic interest rate and inflation risk. If there are no short-sale constraints, the optimal asset allocation strategy can be solved analytically. We consider several kinds of short-sale constraints and employ the backward Markov chain approximation method to explore the impact of short-sale constraints on asset allocation decisions. Our results show that the short-sale constraints do indeed have a significant impact on the asset allocation decisions.

Optimal Investment Strategies under Stochastic Volatility - Estimation and Applications

“…This section provides some concrete investment strategies having exposure to stochastic volatility based on the estimation results in Section 3. Optimal portfolios based on Models 1 and 2 are available in analytical forms while optimal portfolios for Model 3 are obtained through adopting Backward Markov chain approximation methods as in Chiarella and Hsiao (2006).…”

“…The optimal investment strategy which maximized the expected utility (9) can be obtained through the backward Markov chain approximation scheme, which is proposed by Kushner and Dupius (2000)?. Chiarella and Hsiao (2006) applied the scheme to portfolio asset allocation problem. Here we briefly introduce the scheme.…”

“…For the utility function of CRRA type (10), we can decompose the value function into the form as shown in Proposition 5 in Chiarella and Hsiao (2006)…”

“…However, analytical solutions for the extended model with a CEV process are not available. This paper adopt a backward Markov chain approximation method proposed in Chiarella and Hsiao (2006) to provide a computational solution for optimal strategies. This paper considers three models for modelling stochastic volatility (SV) in stock prices: an extended Stein-Stein model, the Heston model and an extended Heston model based on a CEV process.…”