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Article
Optimal Policies for Investment with Time-Varying Return Distributions
Journal of Computational Analysis and Applications (2002)
  • Douglas G Steigerwald, University of California, Santa Barbara
  • Doncho Donchev
  • Svetlozar Rachev
Abstract
We develop a model in which investors must learn the distribution of asset returns over time. The process of learning is made more difficult by the fact that the distributions are not constant through time. We consider risk-neutral investors who have quadratic utility and are selecting between two risky assets. We determine the time at which it is optimal to update the distribution estimate and, hence, alter portfolio weights. Our results deliver an optimal policy for asset allocation, that is, the sequence of time intervals at which it is optimal to switch between assets, based on stochastic optimal control theory. In addition, we determine the time intervals in which asset switching leads to a loss with high probability. We provide estimates of the effectiveness of the optimal policy.
Keywords
  • asset allocation,
  • optimal policy,
  • stochastic control,
  • two-armed bandit
Publication Date
2002
Citation Information
Douglas G Steigerwald, Doncho Donchev and Svetlozar Rachev. "Optimal Policies for Investment with Time-Varying Return Distributions" Journal of Computational Analysis and Applications Vol. 4 Iss. 4 (2002)
Available at: http://works.bepress.com/douglas_steigerwald/7/