Dynamic behaviour of optimal portfolio with stochastic volatility

• Main Authors: Yongmin Zhang, Yingxue Zhao
• Format: Article
• Language: English
• Published: Taylor & Francis Group 2021-01-01
• Series: Ekonomska Istraživanja
• Subjects: portfolio selection; portfolio distribution; dynamic behaviour; heston stochastic volatility model; incomplete market
• Online Access: http://dx.doi.org/10.1080/1331677X.2020.1788407

In the existing literature, little is known about the dynamic behaviour of the optimal portfolio in terms of market inputs and arbitrary stochastic factor dynamics in an incomplete market with a stochastic volatility. In this paper, to study optimal portfolio behaviour, we compute and analyze the mean and the variance of the optimal portfolio and of their adjustment speed in terms of market inputs in an incomplete market. The incompleteness arises from the additional source of uncertainty of the volatility in Heston’s stochastic volatility model. Conducting sensitivity analysis for the mean and the variance of the optimal portfolio process as well as its adjustment speed to the market parameters, we find several interesting behavioural patterns of investors towards asset price and its volatility shocks. Our results are robust and convergent by the agreement from two simulation methods for different time step increments and the number of Monte Carlo simulation paths.