Dynamic programming (DP) is a powerful mathematical technique used in finance to solve complex problems by breaking them down into simpler subproblems. It is particularly useful in situations where decisions need to be made sequentially over time, such as in portfolio optimization, option pricing, and resource allocation. The core idea of DP is to store the solutions of subproblems to avoid redundant calculations, which significantly improves computational efficiency.
In finance, this can be applied in various contexts, including:
Mathematically, the DP approach involves defining a value function that represents the maximum value obtainable from a given state , which is recursively defined based on previous states. This allows for the systematic evaluation of different strategies and the selection of the optimal one.
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