Dynamic asset management with risk-sensitive criterion and non-negative factor constraints: a differential game approach

• Published in: Stochastics (Abingdon, Eng. : 2005) Vol. 81; no. 5; pp. 503 - 530
• Main Authors: Bagchi, Arunabha, Suresh Kumar, K.
• Format: Journal Article
• Language: English
• Published: Taylor & Francis Group 01.10.2009
• Subjects: portfolio optimization; reflecting diffusion; risk-sensitive control; Skorohod problem
• ISSN: 1744-2508; 1744-2516
• DOI: 10.1080/17442500902774917

In this paper, we study continuous time portfolio optimization problem where individual securities are directly affected by economic factors. We consider the risk-sensitive criterion function as is familiar in the robust control literature. This is the natural setting for studying the infinite horizon case of the control problem arising in portfolio optimization. Our result extends earlier works by imposing explicitly the non-negativity constraint on the economic factors. This is achieved by using reflected diffusions. The risk-sensitive control problem with reflected diffusion is then converted into a stochastic differential game. The lower value of this game leads immediately to the desired optimal strategy. Also we prove the existence of unique strong solution to reflected diffusions with bounded measurable drift coefficient which is the first result of its kind for higher dimensional reflected diffusions.