A Primal-Dual Decomposition-Based Interior Point Approach to Two-Stage Stochastic Linear Programming

Abstract

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 which 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 decomposition 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 with our model with market prices of options on the S&P500.