A martingale approach for asset allocation with derivative security and hidden economic risk

Tak Kuen Siu, Jinxia Zhu, Hailiang Yang

Research output: Contribution to journalArticle

1 Citation (Scopus)

Abstract

Asset allocation with a derivative security is studied in a hidden, Markovian regime-switching, economy using filtering theory and the martingale approach. A generalized delta-hedged ratio and a generalized elasticity of an option are introduced to accommodate the presence of the information state process and the derivative security. Malliavin calculus is applied to derive a solution for a general utility function which includes an exponential utility, a power utility, and a logarithmic utility. A compact solution is obtained for a logarithmic utility. Some economic implications of the solutions are discussed.

Original languageEnglish
Pages (from-to)723-749
Number of pages27
JournalJournal of Applied Probability
Volume56
Issue number3
DOIs
Publication statusPublished - 1 Sep 2019

Keywords

  • Asset allocation
  • Derivatives
  • Filtering
  • Malliavin calculus

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