Stochastic switching for partially observable dynamics and optimal asset allocation

ABSTRACT

In industrial applications, optimal control problems frequently appear in the context of decision-making under incomplete information. In such framework, decisions must be adapted dynamically to account for possible regime changes of the underlying dynamics. Using stochastic filtering theory, Markovian evolution can be modelled in terms of latent variables, which naturally leads to high-dimensional state space, making practical solutions to these control problems notoriously challenging. In our approach, we utilise a specific structure of this problem class to present a solution in terms of simple, reliable, and fast algorithms. The algorithms presented in this paper have already been implemented in an R package.

Keywords:

• Dynamic programming
• Markov decisions
• partial observation
• stochastic control
• duality methods

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. The author is grateful to an anonymous referee for pointing out this issue.

Additional information

Funding

This research was supported under Australian Research Council's Discovery Project funding scheme [grant number DP130103315].