Browsing by Subject "Approximations"
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Item Functional approximation methods for solving stochastic control problems in finance(2010-08) Yang, Chunyu, 1979-; Tompaidis, Efstathios, 1967-; Garlappi, Lorenzo; Morton, David; Muthuraman, Kumar; Zariphopoulou, ThaleiaI develop a numerical method that combines functional approximations and dynamic programming to solve high-dimensional discrete-time stochastic control problems under general constraints. The method relies on three building blocks: first, a quasi-random grid and the radial basis function method are used to discretize and interpolate the high-dimensional state space; second, to incorporate constraints, the method of Lagrange multipliers is applied to obtain the first order optimality conditions; third, the conditional expectation of the value function is approximated by a second order polynomial basis, estimated using ordinary least squares regressions. To reduce the approximation error, I introduce the test region iterative contraction (TRIC) method to shrink the approximation region around the optimal solution. I apply the method to two Finance applications: a) dynamic portfolio choice with constraints, a continuous control problem; b) dynamic portfolio choice with capital gain taxation, a high-dimensional singular control problem.