Published: Oct. 18, 2018

Optimal Portfolio under Fractional Stochastic Environments

Rough stochastic volatility models have attracted a lot of attention recently, in particular for the linear option pricing problem. In this paper, starting with power utilities, we propose to use a martingale distortion representation of the optimal value function for the nonlinear asset allocation problem in a (non-Markovian) fractional stochastic environment (for all Hurst index H \in (0,1)). We rigorously establish a first-order approximation of the optimal value, where the return and volatility of the underlying asset are functions of a stationary slowly varying fractional Ornstein-Uhlenbeck process. We prove that this approximation can be also generated by a fixed zeroth order trading strategy providing an explicit strategy which is asymptotically optimal in all admissible controls. Similar results are also obtained under fast mean-reverting fractional stochastic environment. Furthermore, we extend the discussion to general utility functions, and obtain the asymptotic optimality of this fixed strategy in a specific family of admissible strategies.