Asset Allocation in Continuous Time推荐.pdfVIP

CHAPTER 66 asset allocation in continuous time In this Chapter. . . • the wealth process • optimizing over asset holdings and consumption • the Bellman equation • the effect of transaction costs 66.1 INTRODUCTION In Chapter 18 we looked at ways in which to invest optimally assuming that we cannot change our minds later; this is the one-period investment. In practice, we can change our minds as often as we want according to the way that the future unveils itself. In this chapter we examine models for continuous-time investment and portfolio rebalancing. Most of this is taken from Merton’s work. One of the restrictions on rebalancing our portfolio is the cost of transacting. At the end of the chapter we take a brief peek at transaction costs. 66.2 ONE RISK-FREE AND ONE RISKY ASSET To get the ball rolling, let’s first look at investing in just two assets, one risk-free earning a sure rate of r and the other risky following the random walk dS = µS dt + σ S dX. (66.1) We are going to invest a fraction w(t) of our wealth in the risky asset and the remaining fraction 1 − w in the risk-free. We will also choose to consume or spend, spend, spend, at a rate of C(t). Our aim is to decide how to split our money between the two assets and how much to consume; that is we must decide on the best w(t) and C(t). Obviously, we will have to optimize some problem as we’ll shortly see. 1052 Part Five advanced topics 66.2.1 The Wealth Process How does our wealth evolve as the asset prices change and we consume? Can we find a stochastic differential equation for the wealth W ? From one time step to the next our wealth changes for three reasons: The asset S changes randomly; We consume; We earn interest on our cash. The f