Risk Sensitive Asset Management with Transaction Costs
Posted: 23 Feb 2000
This paper develops a continuous time risk-sensitive portfolio optimization model with a general transaction cost structure and where the individual securities or asset categories are explicitly affected by underlying economic factors. The security prices and factors follow diffusion processes with the drift and diffusion coefficients for the securities being functions of the factor levels. We develop methods of risk sensitive impulsive control theory in order to maximize an infinite horizon objective that is natural and features the long run expected growth rate, the asymptotic variance, and a single risk aversion parameter. The optimal trading strategy has a simple characterization in terms of the security prices and the factor levels. Moreover, it can be computed by solving a risk sensitive quasi-variational inequality. The Kelly criterion case is also studied, and the various results are related to the recent work by Morton and Pliska.
JEL Classification: G11
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