Near-Optimal Dynamic Asset Allocation in Financial Markets with Trading Constraints

We develop a dual-control method for approximating investment strategies in the presence of general trading constraints. The approximation is based on closed-form expressions inherent in the dual problem, enabling us to derive the near-optimal asset allocation explicitly. Using convex duality methods, we are able to generate lower and upper bounds on the optimal value function. The difference between these bounds provides an indication of the routine’s precision. We illustrate the accuracy of our approximate method on a dual CRRA utility function in a Brennan and Xia (2002) environment. Resulting negligible duality gaps and insignificant welfare losses demonstrate the potential exactness of the procedure.