Dynamic capital allocation with reallocation cost

Traditional static capital allocation incurs significant reallocation costs over periods due to drastic fluctuations. We propose a new framework for dynamic capital allocation with time -varying capital constraints that incorporates reallocation costs. We obtain an analytical solution in a recursive form and demonstrate its admirable performance through simulations. The solution compromises between static allocation and expected future risk structure and strikes a balance between addressing current risk profiles and adjustment costs. It successfully provides an effective allocation tool while preserving stability. (c) 2024 Elsevier B.V. All rights reserved.