Price Model with Generalized Wiener Process for Life Insurance Company Portfolio Optimization using Mean Absolute Deviation

Abstract

The Financial Services Authority (OJK) has issued Regulation of the Financial Services Authority of the Republic of Indonesia Number 5 Year 2023. Article 11 paragraph 1d explains the limitations of assets allowed in the form of investment, investment in the form of shares listed on the stock exchange for each issuer is a maximum of 10% of the total investment and a maximum of 40% of the total investment. The investment manager of a life insurance company needs to adjust its investment portfolio. In 1991, Konno and Yamazaki proposed an approach to the portfolio selection problem with Mean Absolute Deviation (MAD) model. This model can be solved using linear programming, effectively solving high-dimensional portfolio optimization problems. Another problem in stock portfolio formation is that the ever-changing financial markets demand the development of models to understand and forecast stock price behavior. One method that has been widely used to model stock price movements is the generalized Wiener Process. The generalized Wiener process provides a framework that can accommodate the stochastic nature of stock price changes, thus allowing portfolio managers to be more sensitive to unanticipated market fluctuations. The stock price change model using the Generalized Wiener Process is very good at predicting stock price changes. The results of this stock price prediction can then be used to find the optimal portfolio using the MAD model. The portfolio optimization problem with the MAD model can be solved using linear programming to obtain the optimal stock portfolio for life insurance companies.

Keywords

• generalized wiener process
• mean absolute deviation
• portfolio optimization
• price model.