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1640. Risk-Sensitive Control in Portfolio Choice: Incorporating Ambiguity Aversion and Stochastic Factors

Invited abstract in session WB-2: Optimal Portfolio Strategies, stream OR in Banking, Finance and Insurance: New Tools for Risk Management.

Wednesday, 10:30-12:00
Room: Glassalen (building: 101)

Authors (first author is the speaker)

1. Chi Chung Siu
Department of Mathematics, Statistics and Insurance, The Hang Seng University of Hong Kong
2. Guiyuan Ma
School of Economics and Finance, Xi'an Jiaotong University
3. Dantong Chu
Department of Statistics, Chinese University of Hong Kong
4. Wai Leong Ng
Department of Mathematics, Statistics and Insurance, The Hang Seng University of Hong Kong

Abstract

This paper explores risk-sensitive control in discrete-time portfolio choice. The investor considers stochastic factors and price impacts, including permanent and temporary effects. Ambiguity aversion towards model estimation errors of asset returns and stochastic factors is incorporated. The objective is to maximize the investor's preference for local mean-variance on investment returns, while accounting for mark-to-market profits and losses, execution costs, and penalties related to model estimation errors. Our study reveals that the investor's trading strategy may differ from the aim portfolio. Ambiguity-averse investors tend to trade more conservatively compared to non-robust cases. Trading decisions are influenced by factors like higher permanent price impacts and lower market resilience rates, with trading speed linked to ambiguity aversion. Simulation studies validate the effectiveness of the robust trading strategy, outperforming the non-robust approach. Mark-to-market profits and losses from permanent price impacts enhance the net Sharpe ratio. Incorporating risk-sensitive control techniques in portfolio choice under uncertainty and ambiguity is crucial.

Keywords

Status: accepted

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