Comparing Risk Management Strategy of Merton Dynamic Portfolio with Tangent Portfolio

Abstract

This research delves into the critical importance of enhancing financial literacy and implementing resilient investment strategies through advanced financial education and portfolio management practices. It evaluates the effectiveness of the Tangent Portfolio and the Merton Dynamic Portfolio (MDP) as tools for mitigating interest rate risk. By comparing these strategies across stocks, bonds, commodities, and cash investments in the United States, the United Kingdom, and Thailand, the study aims to determine which portfolio better defends against interest rate fluctuations. The performance of these portfolios is benchmarked against major indices such as the SPX, UK100, and SET, with evaluations conducted on both a monthly and annual basis. A key objective is to assess how these portfolios perform under various interest rate scenarios, providing insights into managing investment risks through strategic asset allocation and liquidity management without relying on derivatives. The study concludes that the MDP demonstrates superior effectiveness in investment portfolio management. It successfully reduces systemic risks and achieves better risk-adjusted returns across the SPX, UK100, and SET indices compared to the Tangent Portfolio. This is primarily due to the utilization of the Hamilton-Jacobi-Bellman (HJB) method and the maximization of utility, which allows the MDP to mitigate portfolio risks more efficiently than traditional optimization methods that rely solely on expected returns and variance. Systemic risks modeled in this study, particularly those related to inflation, were based on stochastic processes and further applied to interest rate modeling. This approach enabled a more dynamic and responsive risk management strategy, underscoring the enhanced performance and resilience of the MDP in various economic conditions. The findings aim to offer pathways for investors to navigate financial uncertainties, with a particular focus on the systemic risks associated with interest rate changes. Ultimately, this research seeks to empower individuals with strategies for sustainable financial growth, enabling them to make informed investment decisions in a complex global market.