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

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  • Carl Chiarella
  • Chih-Ying Hsiao

Abstract

This paper considers an asset allocation strategy over a finite period under investment uncertainty and short-sale constraints as a continuous time 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.
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Suggested Citation

  • Carl Chiarella & Chih-Ying Hsiao, 2006. "The Impact of Short-Sale Constraints on Asset Allocation Strategies via the Backward Markov Chain Approximation Method," Computational Economics, Springer;Society for Computational Economics, vol. 28(2), pages 113-137, September.
    • Handle: RePEc:kap:compec:v:28:y:2006:i:2:p:113-137
    DOI: 10.1007/s10614-006-9036-4
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