A primal-dual decomposition-based interior point approach to two-stage stochastic linear programming

Arjan Berkelaar, Cees Dert, Bart Oldenkamp, Shuzhong Zhang

Decision making under uncertainty is a challenge faced by many decision makers. Stochastic programming is a major tool developed to deal with optimization with uncertainties that has found applications in, e.g. finance, such as asset-liability and bond-portfolio management. Computationally however, many models in stochastic programming remain unsolvable because of overwhelming dimensionality. For a model to be well solvable, its special structure must be explored. Most of the solution methods are based on decomposing the data. In this paper we propose a new decomposition approach for two-stage stochastic programming, based on a direct application of the path-following method combined with the homogeneous self-dual technique. Numerical experiments show that our decomposition algorithm is very efficient for solving stochastic programs. In particular, we apply our deompostition method to a two-period portfolio selection problem using options on a stock index. In this model the investor can invest in a money-market account, a stock index, and European options on this index with different maturities. We experiment our model with market prices of options on the S&P500.

Econometric Institute Report EI-9918/A, Erasmus University Rotterdam, P.O. Box 1738, 3000 DR Rotterdam, The Netherlands. April, 1999.

Contact: [email protected]

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