Assume we are given market with m risky assets. Denote by S_{i}(t) the price of ith asset at time t. We shall assume that the prices of assets depend on k economical factors x_{i}(n), i=1,...,k, with dynamics changes in discrete time moments denoted for simplicity by n=0,1,...., in the following way: for t belonging to the interval [n,n+1),
dS_{i}(t)/S_{i}(t)=a_{i}(x(n))dt+Σ_{j=1}^{k+m}σ_{ij}(x(n))dw_{j}(t), (1)
where (w(t)=(w_{1}(t),w_{2}(t),..., w_{k+m}(t)) is a k+m dimensional Brownian motion defined on a given probability space (Ω,(F_{t}),F). Economical factors x(n)=(x_{1}(n),...,x_{k}(n)), satisfy the equation:
x_{i}(n+1)=x_{i}(n)+b_{i}(x(n))+Σ_{j=1}^{k+m}d_{ij}(x(n))(w_{j}(n+1)w_{j}(n))=g(x(n),W(n)), (2)
where W(n):=(w_{1}(n+1)w_{1}(n),...,w_{k+m}(n+1)w_{k+m}(n)).
We assume that 'a', 'b' are bounded continuous vector functions, and 'σ ', 'd' are bounded continuous matrix functions of suitable dimensions. Additionally we shall assume that the matrix dd^{T} (the superscript 'T' stands for transponse) is nondegenerate. Notice that equation (2) corresponds to discretization of a diffusion process. The set of factors may include divident yields, price  earning rations, short term interest rates, the rate of inflation see e.g. [1]. The dynamics of such factors is usually modeled using diffusion, frequently linear equations eg. in the case when we assume following [1] that 'a' is a function of spot interest rate governed by the Vasicek process. Our assumptions concerning boundedness of vector functions 'a' and 'b' may be relaxed allowing linear growth, however in such case we shall need other more complicated assumptions.
Assume that starting with an initial capital V(0) we invest in assets. Let h_{i}(n) be the part of the wealth process located in the ith asset at time n, which is assumed to be nonnegative. The choice of h_{i}(n) depends on our observation of the asset prices and economical factors up to time 'n'. Denoting by V(n) the wealth process at time 'n' and by h(n)=(h_{1}(n), ...,h_{m}(n)) our investment strategy at time 'n', we have that h(n) belongs to U={(h_{1},...,h_{m}), h_{i} >=0, Σ_{i=1}^{m} h_{i}=1} and
V(n+1)/V(n) = Σ_{i=1}^{m} h_{i}(n)ξ_{i}(x(n),W(n)), (3)
where
ξ_{i}(x(n),W(n))=exp{a_{i}(x(n))σ^{2}_{ij}(x(n))/2 + Σ_{j=1}^{k+m}σ_{ij}(x(n))(w_{j}(n+1)w_{j}(n))}.
We are interested in the following investment problems: maximize risk neutral cost functional
J^{0}_{x}(h(n))= lim inf_{n>oo} {{E_{x}{lnV(n)}}/n}, (4)
and maximize risk sensitive cost functional
J^{0}_{x}(h(n))= {lim sup_{n>oo} {{E_{x}{V(n)^{γ}}}/n}}/γ , (5)
with γ <0. Using (3) we can write the cost functionals (4) and (5) in the more convenient forms. Namely,
J^{0}_{x}(h(n))= lim inf_{n>oo} {{E_{x}{Σ_{t=0}^{n1} ln (Σ_{i=1}^{m} h_{i}(t)ξ_{i}(x(t),h(t))}}/n} =lim inf_{n>\infty} {{E_{x}{Σ_{t=0}^{n1} c(x(t),h(t))}}/n}, (6),
with c(x,h)=E{ln(Σ_{i=1}^{m}h_{i}ξ_{i}(x,W(0)))}. It is clear that risk neutral cost functional J^{0} depends on uncontrolled Markov process (x(n)) and we practically maximize the cost function c itself. Consequently an optional control is of the form control (u'(x(n)), where sup_{h} c(x,h)=c(x, u'(x)) and function Borel measurable u': R^{k} > U exists by continuity of c for fixed x belonging to R^{k}. This control does not depend on asset prices and is a time independent function of current values of the factors x only. The Bellman equation corresponding to the risk neutral control problem is of the form
w(x) + λ = sup_{h} (c(x,h) + Pw(x)), (7)
where Pf(x):= E_{x}{f(x(1))} for f belonging to bB(R^{k})  the space of bounded Borel measurable functions on R^{k}, is a transition operator corresponding to (x(n)). We shall show that there are solutions w and λ to the equation (7) and λ is an optimal value of the cost functional J^{0}. Letting
ξ^{h,γ }_{n}(ω):= Π_{t=0}^{n1}exp{γ ln (Σ_{i=1}^{m} h_{i}(t)ξ_{i}(x(t),W(t)))}(E{exp{γ ln (Σ_{i=1}^{m} h_{i}(t)ξ_{i}(x(t),W(t))}F_{t}})^{1}
consider a probability measure P^{h,γ} defined by its restrictions P^{h,γ} to the first n time moments given by the formula
P_{n}^{h,γ}=ξ^{h,γ}_{n}(ω)=P_{n}(dω ).
Then
J_{x}^{γ}(h(n))={lim sup _{n>oo}{ln E_{x}{exp{γ Σ_{t=0}^{n1}ln(Σ_{i=1}^{m} h_{i}(t)ξ_{i}(x(t), W(t)))}}/n}}/γ ={lim sup_{n>oo} {ln E^{h,γ}_{x}{exp{Σ_{t=0}^{n1} c_{γ}(x(t),h(t))}}/n}}/γ, (8)
with
c_{γ}(x,h):=ln(E{(Σ_{i=1}^{m} h_{i}ξ_{i}(x,W(0)))^{γ}}). (9)
Risk sensitive Bellman equation corresponding to the cost functional J^{γ} is of the form
exp(w_{γ}(x))=inf_{h} {exp(c_{γ}(x,h)λ_{γ})\int_{E} exp(w_{γ}(y))P^{h,γ}(x,dy)}, (10)
where for f belonging to bB(R^{k})
P^{h,γ}=E{(Σ_{i=1}^{m} h_{i}ξ(x,W(0)))^{γ}exp{c_{γ}(x,h)f(g(x,W(0)))}, (11)
and where λ_{γ}/γ corresponds to optimal value of the cost functional (8). Notice that under measure P^{h,γ} the process (x(n)) is still Markov but with controlled transition operator P^{h,γ}(x,dy). Following [5] we shall show that
λ_{γ}/γ > 0
whenever γ >0.
The study of risk sensitive portfolio optimization has been originated in [1] and then continued in a number of papers in particular in [12]. Risk sensitive cost functional was studied in papers [9], [5], [6], [3], [4], [8], [2], [7] and references therein. Using splitting of Markov processes arguments (see [11]) we study Poisson equation for additive cost functional the solution of which is also a solution to risk neutral Bellman equation. We consider then risk sensitive portfolio optimization with risk factor close to 0. We generalize the result of [12], where uniform ergodicity of factors was required and using [7] show the existence of Bellman equation for small risk in a more general ergodic case. The proof of that nearly optimal continuous risk neutral control function is also nearly optimal for risk sensitive cost functional with risk factor close to 0 is based on modification of the arguments of [5] using some results from the theory of large deviations.
References
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[3] R. CavazosCadena, "Solution to the risksensitive average cost optimality in a class of Markov decision processes with finite state space", Math. Meth. Oper. Res., 57 (2003), pp. 263285.
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[9] D. HernandezHernandez, S.J. Marcus, "Risk sensitive control of Markov processes in countable state space", Sys. Control Letters, 29 (1996), pp. 147155.
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