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A closed-form solution of the multi-period portfolio choice problem for a quadratic utility function

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  • Taras Bodnar
  • Nestor Parolya
  • Wolfgang Schmid

Abstract

In the present paper, we derive a closed-form solution of the multi-period portfolio choice problem for a quadratic utility function with and without a riskless asset. All results are derived under weak conditions on the asset returns. No assumption on the correlation structure between different time points is needed and no assumption on the distribution is imposed. All expressions are presented in terms of the conditional mean vectors and the conditional covariance matrices. If the multivariate process of the asset returns is independent, it is shown that in the case without a riskless asset the solution is presented as a sequence of optimal portfolio weights obtained by solving the single-period Markowitz optimization problem. The process dynamics are included only in the shape parameter of the utility function. If a riskless asset is present, then the multi-period optimal portfolio weights are proportional to the single-period solutions multiplied by time-varying constants which are dependent on the process dynamics. Remarkably, in the case of a portfolio selection with the tangency portfolio the multi-period solution coincides with the sequence of the single-period solutions. Finally, we compare the suggested strategies with existing multi-period portfolio allocation methods on real data. Copyright Springer Science+Business Media New York 2015

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  • Taras Bodnar & Nestor Parolya & Wolfgang Schmid, 2015. "A closed-form solution of the multi-period portfolio choice problem for a quadratic utility function," Annals of Operations Research, Springer, vol. 229(1), pages 121-158, June.
    • Handle: RePEc:spr:annopr:v:229:y:2015:i:1:p:121-158:10.1007/s10479-015-1802-z
    DOI: 10.1007/s10479-015-1802-z
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    Cited by:

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    2. Dmytro Ivasiuk, 2019. "An approximate solution for the power utility optimization under predictable returns," Papers 1911.06552, arXiv.org, revised Oct 2021.
    3. Bauder, David & Bodnar, Taras & Parolya, Nestor & Schmid, Wolfgang, 2020. "Bayesian inference of the multi-period optimal portfolio for an exponential utility," Journal of Multivariate Analysis, Elsevier, vol. 175(C).
    4. Ling, Aifan & Sun, Jie & Wang, Meihua, 2020. "Robust multi-period portfolio selection based on downside risk with asymmetrically distributed uncertainty set," European Journal of Operational Research, Elsevier, vol. 285(1), pages 81-95.
    5. N'Golo Kone, 2020. "A Multi-Period Portfolio Selection in a Large Financial Market," Working Paper 1439, Economics Department, Queen's University.
    6. Gatzert, Nadine & Martin, Alexander & Schmidt, Martin & Seith, Benjamin & Vogl, Nikolai, 2021. "Portfolio optimization with irreversible long-term investments in renewable energy under policy risk: A mixed-integer multistage stochastic model and a moving-horizon approach," European Journal of Operational Research, Elsevier, vol. 290(2), pages 734-748.
    7. Bodnar, Taras & Mazur, Stepan & Okhrin, Yarema, 2017. "Bayesian estimation of the global minimum variance portfolio," European Journal of Operational Research, Elsevier, vol. 256(1), pages 292-307.
    8. Taras Bodnar & Dmytro Ivasiuk & Nestor Parolya & Wolfgang Schmid, 2023. "Multi-period power utility optimization under stock return predictability," Computational Management Science, Springer, vol. 20(1), pages 1-27, December.
    9. Taras Bodnar & Dmytro Ivasiuk & Nestor Parolya & Wofgang Schmid, 2018. "Mean-Variance Efficiency of Optimal Power and Logarithmic Utility Portfolios," Papers 1806.08005, arXiv.org, revised May 2019.

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