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Downside Risk Control in Continuous Time Portfolio Management

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Abstract

Institutionally managed savings have dramatically increased in recent decades. In order to ensure that portfolio managers work directly for investors, controlling downside risk is a crucial mechanism in the agent's asset allocation strategy. In this paper, we extend the agent's asset allocation problem by incorporating multi-period downside control over the time-varying opportunity set. We show that optimal asset allocation can be regarded as a series of separate dynamic strategies in replicating the synthetic call options with the utility-related mutual fund and guarantee exercise. Numerical simulations show that increasing the minimum effectively increases the equity holding. Moreover, fund managers are inclined to hold only fixed income portfolios once the target return is obtained.

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