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The Impact of Short-Sale Constraints on Asset Allocation Strategies via the Backward Markov Chain Approximation Method

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Abstract

This paper considers an asset allocation strategy over a finite period under investment uncertainty and short-sale constraints as a continuous-time stochastic control problem. Investment uncertainty is characterised by a stochastic interest rate and inflation risk. If there are no short-sale constraints, the optimal asset allocation strategy can be obtained analytically. We consider several kinds of short-sale constraints and employ the backward Markov chain approximation method to explore the impact of short-sale constraints on asset allocation decisions. Our results show that the short-sale constraints do indeed have a significant impact on these decisions.

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Authors and Affiliations

  1. School of Finance and Economics, University of Technology, Sydney, Australia

    Carl Chiarella & Chih-Ying Hsiao

  2. University of Bielefeld, Bielefeld, Germany

    Chih-Ying Hsiao

Authors
  1. Carl Chiarella
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  2. Chih-Ying Hsiao
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Chiarella, C., Hsiao, CY. The Impact of Short-Sale Constraints on Asset Allocation Strategies via the Backward Markov Chain Approximation Method. Comput Econ 28, 113–137 (2006). https://doi.org/10.1007/s10614-006-9036-4

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  • DOI: https://doi.org/10.1007/s10614-006-9036-4

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