A dynamic stochastic network model for asset allocation problem

Abstract

Asset allocation is an important decision problem in financial planning. In this paper, we study the multistage dynamic asset allocation problem in which an investor is allowed to reallocate its wealth among a set of assets over finite discrete decision points and the stochastic return rates of the assets follow aMarkov chain with nonstationary transition probabilities. The objective is to maximize the utility of the wealth at the end of the planning horizon where the utility of the wealth follows a general piecewise linear and concave function. Transaction costs are considered. We formulate the problem with a dynamic stochastic network model which has potential to introduce a computationally tractable tool to deal with the dynamic asset allocation problem of large number of assets and long planning horizon. © 2009 IEEE.