Optimal Investment Problem in a Financial Institution: The Effect of Risk Aversion and Market Price of Risk Parameters on Optimal Investment

Abstract

This research work looked at how to optimally allocate the total wealth of a financial institution in asset portfolio that is made up of three assets, which are treasury, security and loan. In the financial institution’s portfolio optimization problem, the interest rate is stochastic, the volatility of the security price is assumed to be described by the model of Heston stochastic volatility. By applying stochastic optimization theory, we obtained the optimum investment policy or strategy for the financial institution for the case of utility function which is constant relative risk aversion (CRRA). Numerical examples were also given to illustrate the dynamics of the optimum investment policy.