Jump-Diffusion Risk-Sensitive Asset Management I: Diffusion Factor Model

2010/01/08 by Davis, Mark, Lleo, Sebastien
#FOS: Economics and business #Portfolio Management (q-fin.PM)

paper · doi:10.48550/arxiv.1001.1379

Abstract

This paper considers a portfolio optimization problem in which asset prices are represented by SDEs driven by Brownian motion and a Poisson random measure, with drifts that are functions of an auxiliary diffusion factor process. The criterion, following earlier work by Bielecki, Pliska, Nagai and others, is risk-sensitive optimization (equivalent to maximizing the expected growth rate subject to a constraint on variance.) By using a change of measure technique introduced by Kuroda and Nagai we show that the problem reduces to solving a certain stochastic control problem in the factor process, which has no jumps. The main result of the paper is to show that the risk-sensitive jump diffusion problem can be fully characterized in terms of a parabolic Hamilton-Jacobi-Bellman PDE rather than a PIDE, and that this PDE admits a classical C^1,2 solution.

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