Quantcast

OPTIMAL ASSET ALLOCATION WITH STOCHASTIC INTEREST RATES IN REGIME-SWITCHING MODELS

Research paper by C. YE, R. H. LIU, D. REN

Indexed on: 14 Jul '18Published on: 18 Jun '18Published in: International Journal of Theoretical and Applied Finance



Abstract

International Journal of Theoretical and Applied Finance, Ahead of Print. 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.