Risk Sensitive Asset Management with Transaction Costs

Posted: 23 Feb 2000

See all articles by Tomasz R. Bielecki

Tomasz R. Bielecki

Illinois Institute of Technology

Stanley R. Pliska

University of Illinois at Chicago - Department of Finance

Abstract

This paper develops a continuous time risk-sensitive portfolio optimization model with a general transaction cost structure and where the individual securities or asset categories are explicitly affected by underlying economic factors. The security prices and factors follow diffusion processes with the drift and diffusion coefficients for the securities being functions of the factor levels. We develop methods of risk sensitive impulsive control theory in order to maximize an infinite horizon objective that is natural and features the long run expected growth rate, the asymptotic variance, and a single risk aversion parameter. The optimal trading strategy has a simple characterization in terms of the security prices and the factor levels. Moreover, it can be computed by solving a risk sensitive quasi-variational inequality. The Kelly criterion case is also studied, and the various results are related to the recent work by Morton and Pliska.

JEL Classification: G11

Suggested Citation

Bielecki, Tomasz R. and Pliska, Stanley R., Risk Sensitive Asset Management with Transaction Costs. Available at SSRN: https://ssrn.com/abstract=191608

Tomasz R. Bielecki (Contact Author)

Illinois Institute of Technology ( email )

Department of Applied Mathematics
10 W. 32nd Street
Chicago, IL 60616
United States
312 567 3185 (Phone)
312 567 3135 (Fax)

Stanley R. Pliska

University of Illinois at Chicago - Department of Finance ( email )

2431 University Hall (UH)
601 S. Morgan Street
Chicago, IL 60607-7124
United States
312-996 7170 (Phone)

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