A Stochastic Dynamic Programming Approach Based on Bounded Rationality and Application to Dynamic Portfolio Choice
Dynamic portfolio choice is an important problem in finance, but the optimal strategy analysis is difficult when considering multiple stochastic volatility variables such as the stock price, interest rate, and income. Besides, recent research in experimental economics indicates that the agent shows...
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| Main Authors: | , , , |
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| Format: | Article |
| Language: | English |
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Wiley
2014-01-01
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| Series: | Discrete Dynamics in Nature and Society |
| Online Access: | http://dx.doi.org/10.1155/2014/840725 |
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| _version_ | 1849395223871881216 |
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| author | Wenjie Bi Liuqing Tian Haiying Liu Xiaohong Chen |
| author_facet | Wenjie Bi Liuqing Tian Haiying Liu Xiaohong Chen |
| author_sort | Wenjie Bi |
| collection | DOAJ |
| description | Dynamic portfolio choice is an important problem in finance, but the optimal strategy analysis is difficult when considering multiple stochastic volatility variables such as the stock price, interest rate, and income. Besides, recent research in experimental economics indicates that the agent shows limited attention, considering only the variables with high fluctuations but ignoring those with small ones. By extending the sparse max method, we propose an approach to solve dynamic programming problem with small stochastic volatility and the agent’s bounded rationality. This approach considers the agent’s behavioral factors and avoids effectively the “Curse of Dimensionality” in a dynamic programming problem with more than a few state variables. We then apply it to Merton dynamic portfolio choice model with stochastic volatility and get a tractable solution. Finally, the numerical analysis shows that the bounded rational agent may pay no attention to the varying equity premium and interest rate with small variance. |
| format | Article |
| id | doaj-art-ade439b1e5b243da842748e78538c943 |
| institution | Kabale University |
| issn | 1026-0226 1607-887X |
| language | English |
| publishDate | 2014-01-01 |
| publisher | Wiley |
| record_format | Article |
| series | Discrete Dynamics in Nature and Society |
| spelling | doaj-art-ade439b1e5b243da842748e78538c9432025-08-20T03:39:41ZengWileyDiscrete Dynamics in Nature and Society1026-02261607-887X2014-01-01201410.1155/2014/840725840725A Stochastic Dynamic Programming Approach Based on Bounded Rationality and Application to Dynamic Portfolio ChoiceWenjie Bi0Liuqing Tian1Haiying Liu2Xiaohong Chen3Business School, Central South University, Changsha, Hunan 410083, ChinaBusiness School, Central South University, Changsha, Hunan 410083, ChinaBusiness School, Central South University, Changsha, Hunan 410083, ChinaBusiness School, Central South University, Changsha, Hunan 410083, ChinaDynamic portfolio choice is an important problem in finance, but the optimal strategy analysis is difficult when considering multiple stochastic volatility variables such as the stock price, interest rate, and income. Besides, recent research in experimental economics indicates that the agent shows limited attention, considering only the variables with high fluctuations but ignoring those with small ones. By extending the sparse max method, we propose an approach to solve dynamic programming problem with small stochastic volatility and the agent’s bounded rationality. This approach considers the agent’s behavioral factors and avoids effectively the “Curse of Dimensionality” in a dynamic programming problem with more than a few state variables. We then apply it to Merton dynamic portfolio choice model with stochastic volatility and get a tractable solution. Finally, the numerical analysis shows that the bounded rational agent may pay no attention to the varying equity premium and interest rate with small variance.http://dx.doi.org/10.1155/2014/840725 |
| spellingShingle | Wenjie Bi Liuqing Tian Haiying Liu Xiaohong Chen A Stochastic Dynamic Programming Approach Based on Bounded Rationality and Application to Dynamic Portfolio Choice Discrete Dynamics in Nature and Society |
| title | A Stochastic Dynamic Programming Approach Based on Bounded Rationality and Application to Dynamic Portfolio Choice |
| title_full | A Stochastic Dynamic Programming Approach Based on Bounded Rationality and Application to Dynamic Portfolio Choice |
| title_fullStr | A Stochastic Dynamic Programming Approach Based on Bounded Rationality and Application to Dynamic Portfolio Choice |
| title_full_unstemmed | A Stochastic Dynamic Programming Approach Based on Bounded Rationality and Application to Dynamic Portfolio Choice |
| title_short | A Stochastic Dynamic Programming Approach Based on Bounded Rationality and Application to Dynamic Portfolio Choice |
| title_sort | stochastic dynamic programming approach based on bounded rationality and application to dynamic portfolio choice |
| url | http://dx.doi.org/10.1155/2014/840725 |
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