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Optimal Asset Allocation With Stochastic Interest Rates In Regime-Switching Models

Author

Listed:
  • C. YE

    (Department of Mathematics, University of Dayton, 300 College Park, Dayton, OH 45469, USA)

  • R. H. LIU

    (Department of Mathematics, University of Dayton, 300 College Park, Dayton, OH 45469, USA)

  • D. REN

    (Department of Mathematics, University of Dayton, 300 College Park, Dayton, OH 45469, USA)

Abstract

This paper focuses on optimal asset allocation with stochastic interest rates in regime-switching models. A class of stochastic optimal control problems with Markovian regime-switching is formulated for which a verification theorem is provided. The theory is applied to solve two portfolio optimization problems (a portfolio of stock and savings account and a portfolio of mixed stock, bond and savings account) while a regime-switching Vasicek model is assumed for the interest rate. Closed-form solutions are obtained for a regime-switching power utility function. Numerical results are provided to illustrate the impact of regime-switching on the optimal investment decisions.

Suggested Citation

  • C. Ye & R. H. Liu & D. Ren, 2018. "Optimal Asset Allocation With Stochastic Interest Rates In Regime-Switching Models," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 21(05), pages 1-32, August.
    • Handle: RePEc:wsi:ijtafx:v:21:y:2018:i:05:n:s0219024918500322
    DOI: 10.1142/S0219024918500322
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    References listed on IDEAS

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    1. Ravi Bansal & Hao Zhou, 2002. "Term Structure of Interest Rates with Regime Shifts," Journal of Finance, American Finance Association, vol. 57(5), pages 1997-2043, October.
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    3. Q. Zhang & G. Yin, 2004. "Nearly-Optimal Asset Allocation in Hybrid Stock Investment Models," Journal of Optimization Theory and Applications, Springer, vol. 121(2), pages 419-444, May.
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    7. Jörn Sass & Ulrich Haussmann, 2004. "Optimizing the terminal wealth under partial information: The drift process as a continuous time Markov chain," Finance and Stochastics, Springer, vol. 8(4), pages 553-577, November.
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