The Annals of Applied Probability

Cone-constrained continuous-time Markowitz problems

Christoph Czichowsky and Martin Schweizer

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The Markowitz problem consists of finding, in a financial market, a self-financing trading strategy whose final wealth has maximal mean and minimal variance. We study this in continuous time in a general semimartingale model and under cone constraints: trading strategies must take values in a (possibly random and time-dependent) closed cone. We first prove existence of a solution for convex constraints by showing that the space of constrained terminal gains, which is a space of stochastic integrals, is closed in $L^{2}$. Then we use stochastic control methods to describe the local structure of the optimal strategy, as follows. The value process of a naturally associated constrained linear-quadratic optimal control problem is decomposed into a sum with two opportunity processes $L^{\pm}$ appearing as coefficients. The martingale optimality principle translates into a drift condition for the semimartingale characteristics of $L^{\pm}$ or equivalently into a coupled system of backward stochastic differential equations for $L^{\pm}$. We show how this can be used to both characterize and construct optimal strategies. Our results explain and generalize all the results available in the literature so far. Moreover, we even obtain new sharp results in the unconstrained case.

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Ann. Appl. Probab., Volume 23, Number 2 (2013), 764-810.

First available in Project Euclid: 12 February 2013

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Primary: 91G10: Portfolio theory 91G80: Financial applications of other theories (stochastic control, calculus of variations, PDE, SPDE, dynamical systems) 93E20: Optimal stochastic control 60G48: Generalizations of martingales 49N10: Linear-quadratic problems

Markowitz problem cone constraints portfolio selection mean-variance hedging stochastic control semimartingales BSDEs martingale optimality principle opportunity process $\mathcal{E}$-martingales linear-quadratic control


Czichowsky, Christoph; Schweizer, Martin. Cone-constrained continuous-time Markowitz problems. Ann. Appl. Probab. 23 (2013), no. 2, 764--810. doi:10.1214/12-AAP855.

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