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Expected Power-Utility Maximization Under Incomplete Information and with Cox-Process Observations

Research paper by Kazufumi Fujimoto, Hideo Nagai, Wolfgang J. Runggaldier

Indexed on: 19 Sep '12Published on: 19 Sep '12Published in: Applied Mathematics & Optimization



Abstract

We consider the problem of maximization of expected terminal power utility (risk sensitive criterion). The underlying market model is a regime-switching diffusion model where the regime is determined by an unobservable factor process forming a finite state Markov process. The main novelty is due to the fact that prices are observed and the portfolio is rebalanced only at random times corresponding to a Cox process where the intensity is driven by the unobserved Markovian factor process as well. This leads to a more realistic modeling for many practical situations, like in markets with liquidity restrictions; on the other hand it considerably complicates the problem to the point that traditional methodologies cannot be directly applied. The approach presented here is specific to the power-utility. For log-utilities a different approach is presented in Fujimoto et al. (Preprint, 2012).