Stochastic Optimization of a Multi-currency Bond Portfolio

Huoponen, T. (1994). Stochastic Optimization of a Multi-currency Bond Portfolio. IIASA Working Paper. IIASA, Laxenburg, Austria: WP-94-098

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Abstract

This paper presents a stochastic optimization approach for the management of multi-currency government bond portfolio. This practical problem of optimal fund allocation is formulated as a linearly constrained two-stage model where the parameter values are not known with certainty but depend on future course of underlying stochastic economic variables. The model differs from the standard two-stage formulation as data for the second stage problem is uncertain as well. The objective is to maximize the expected utility of the market value of the portfolio at the end of the planning horizon. To solve the problem, we employ a stochastic quasigradient method by Ermoliev. For the optimality test, upper and lower estimates for the optimal objective function value are developed based on a given confidence level. According to initial numerical results, the convergence to a satisfactory near-optimal solution is considered sufficiently fast for a practical application.

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