Downside risk minimization via a large deviations approach

Abstract

We consider minimizing the probability of falling below a target growth rate of the wealth process up to a time horizon $T$ in an incomplete market model, and then study the asymptotic behavior of minimizing probability as $T\to \infty$. This problem can be closely related to an ergodic risk-sensitive stochastic control problem in the risk-averse case. Indeed, in our main theorem, we relate the former problem concerning the asymptotics for risk minimization to the latter as its dual. As a result, we obtain an expression of the limit value of the probability as the Legendre transform of the value of the control problem, which is characterized as the solution to an H-J-B equation of ergodic type, in the case of a Markovian incomplete market model.

Published in at http://dx.doi.org/10.1214/11-AAP781 the Annals of Applied Probability (http://www.imstat.org/aap/) by the Institute of Mathematical Statistics (http://www.imstat.org)