655 research outputs found
Pairs Trading under Drift Uncertainty and Risk Penalization
In this work, we study a dynamic portfolio optimization problem related to
pairs trading, which is an investment strategy that matches a long position in
one security with a short position in another security with similar
characteristics. The relationship between pairs, called a spread, is modeled by
a Gaussian mean-reverting process whose drift rate is modulated by an
unobservable continuous-time, finite-state Markov chain. Using the classical
stochastic filtering theory, we reduce this problem with partial information to
the one with full information and solve it for the logarithmic utility
function, where the terminal wealth is penalized by the riskiness of the
portfolio according to the realized volatility of the wealth process. We
characterize optimal dollar-neutral strategies as well as optimal value
functions under full and partial information and show that the certainty
equivalence principle holds for the optimal portfolio strategy. Finally, we
provide a numerical analysis for a toy example with a two-state Markov chain.Comment: 24 pages, 4 figure
Executive stock option exercise with full and partial information on a drift change point
We analyse the optimal exercise of an executive stock option (ESO) written on
a stock whose drift parameter falls to a lower value at a change point, an
exponentially distributed random time independent of the Brownian motion
driving the stock. Two agents, who do not trade the stock, have differing
information on the change point, and seek to optimally exercise the option by
maximising its discounted payoff under the physical measure. The first agent
has full information, and observes the change point. The second agent has
partial information and filters the change point from price observations. This
scenario is designed to mimic the positions of two employees of varying
seniority, a fully informed executive and a partially informed less senior
employee, each of whom receives an ESO. The partial information scenario yields
a model under the observation filtration in which the
stock drift becomes a diffusion driven by the innovations process, an
-Brownian motion also driving the stock under
, and the partial information optimal stopping value
function has two spatial dimensions. We rigorously characterise the free
boundary PDEs for both agents, establish shape and regularity properties of the
associated optimal exercise boundaries, and prove the smooth pasting property
in both information scenarios, exploiting some stochastic flow ideas to do so
in the partial information case. We develop finite difference algorithms to
numerically solve both agents' exercise and valuation problems and illustrate
that the additional information of the fully informed agent can result in
exercise patterns which exploit the information on the change point, lending
credence to empirical studies which suggest that privileged information of bad
news is a factor leading to early exercise of ESOs prior to poor stock price
performance.Comment: 48 pages, final version, accepted for publication in SIAM Journal on
Financial Mathematic
The History of the Quantitative Methods in Finance Conference Series. 1992-2007
This report charts the history of the Quantitative Methods in Finance (QMF) conference from its beginning in 1993 to the 15th conference in 2007. It lists alphabetically the 1037 speakers who presented at all 15 conferences and the titles of their papers.
Dynamics of Social Networks: Multi-agent Information Fusion, Anticipatory Decision Making and Polling
This paper surveys mathematical models, structural results and algorithms in
controlled sensing with social learning in social networks.
Part 1, namely Bayesian Social Learning with Controlled Sensing addresses the
following questions: How does risk averse behavior in social learning affect
quickest change detection? How can information fusion be priced? How is the
convergence rate of state estimation affected by social learning? The aim is to
develop and extend structural results in stochastic control and Bayesian
estimation to answer these questions. Such structural results yield fundamental
bounds on the optimal performance, give insight into what parameters affect the
optimal policies, and yield computationally efficient algorithms.
Part 2, namely, Multi-agent Information Fusion with Behavioral Economics
Constraints generalizes Part 1. The agents exhibit sophisticated decision
making in a behavioral economics sense; namely the agents make anticipatory
decisions (thus the decision strategies are time inconsistent and interpreted
as subgame Bayesian Nash equilibria).
Part 3, namely {\em Interactive Sensing in Large Networks}, addresses the
following questions: How to track the degree distribution of an infinite random
graph with dynamics (via a stochastic approximation on a Hilbert space)? How
can the infected degree distribution of a Markov modulated power law network
and its mean field dynamics be tracked via Bayesian filtering given incomplete
information obtained by sampling the network? We also briefly discuss how the
glass ceiling effect emerges in social networks.
Part 4, namely \emph{Efficient Network Polling} deals with polling in large
scale social networks. In such networks, only a fraction of nodes can be polled
to determine their decisions. Which nodes should be polled to achieve a
statistically accurate estimates
Dynamic Credit Investment in Partially Observed Markets
We consider the problem of maximizing expected utility for a power investor
who can allocate his wealth in a stock, a defaultable security, and a money
market account. The dynamics of these security prices are governed by geometric
Brownian motions modulated by a hidden continuous time finite state Markov
chain. We reduce the partially observed stochastic control problem to a
complete observation risk sensitive control problem via the filtered regime
switching probabilities. We separate the latter into pre-default and
post-default dynamic optimization subproblems, and obtain two coupled
Hamilton-Jacobi-Bellman (HJB) partial differential equations. We prove
existence and uniqueness of a globally bounded classical solution to each HJB
equation, and give the corresponding verification theorem. We provide a
numerical analysis showing that the investor increases his holdings in stock as
the filter probability of being in high growth regimes increases, and decreases
his credit risk exposure when the filter probability of being in high default
risk regimes gets larger
The optimal hedging in a semi-Markov modulated market
This paper includes an original self contained proof of well-posedness of an
initial-boundary value problem involving a non-local parabolic PDE which
naturally arises in the study of derivative pricing in a generalized market
model. We call this market model a semi-Markov modulated market. Although a
wellposedness result of that problem is available in the literature, but this
recent paper has a different proof. Here the existence of solution is
established without invoking mild solution technique. We study the
well-posedness of the initial-boundary value problem via a Volterra integral
equation of second kind. The method of conditioning on stopping times was used
only for showing uniqueness. Furthermore, in the present study we find an
integral representation of the PDE problem which enables us to find a robust
numerical scheme to compute derivative of the solution. This study paves for
addressing many other interesting problems involving this new set of PDEs. Some
derivations of external cash flow corresponding to an optimal strategy are
presented. These quantities are extremely important when dealing with an
incomplete market. Apart from these, the risk measures for discrete trading are
formulated which may be of interest to the practitioners.Comment: 23 pages, 4 figure
Optimal stopping problems in mathematical finance
This thesis is concerned with the pricing of American-type contingent claims. First, the explicit solutions to the perpetual American compound option pricing problems in the Black-Merton-Scholes model for financial markets are presented. Compound options are financial contracts which give their holders the right (but not the obligation) to buy or sell some other options at certain times in the future by the strike prices given. The method of proof
is based on the reduction of the initial two-step optimal stopping problems for the underlying geometric Brownian motion to appropriate sequences of ordinary one-step problems. The latter are solved through their associated one-sided free-boundary problems and the subsequent martingale verification for ordinary differential operators. The closed form solution to the perpetual
American chooser option pricing problem is also obtained, by means of the analysis of the equivalent two-sided free-boundary problem. Second, an extension of the Black-Merton-Scholes model with piecewise-constant dividend
and volatility rates is considered. The optimal stopping problems related to the pricing of the perpetual American standard put and call options are solved in closed form. The method of proof is based on the reduction of the initial optimal stopping problems to the associated free-boundary problems and the subsequent martingale verification using a local time-space formula. As a result, the explicit algorithms determining the constant hitting thresholds for the underlying asset price process, which provide the optimal exercise boundaries for the options,
are presented. Third, the optimal stopping games associated with perpetual convertible bonds in an extension of the Black-Merton-Scholes model with random dividends under different information flows are studied. In this type of contracts, the writers have a right to withdraw the bonds
before the holders can exercise them, by converting the bonds into assets. The value functions and the stopping boundaries' expressions are derived in closed-form in the case of observable dividend rate policy, which is modelled by a continuous-time Markov chain. The analysis of the associated parabolic-type free-boundary problem, in the case of unobservable dividend rate policy, is also presented and the optimal exercise times are proved to be the first times at which the asset price process hits boundaries depending on the running state of the filtering dividend rate estimate. Moreover, the explicit estimates for the value function and the optimal exercise boundaries, in the case in which the dividend rate is observable by the writers but unobservable by the holders of the bonds, are presented. Finally, the optimal stopping problems related to the pricing of perpetual American options in an extension of the Black-Merton-Scholes model, in which the dividend and volatility rates of the underlying risky asset depend on the running values of its maximum and its maximum
drawdown, are studied. The latter process represents the difference between the running maximum and the current asset value. The optimal stopping times for exercising are shown to be the first times, at which the price of the underlying asset exits some regions restricted by
certain boundaries depending on the running values of the associated maximum and maximum drawdown processes. The closed-form solutions to the equivalent free-boundary problems for the value functions are obtained with smooth fit at the optimal stopping boundaries and normal reflection at the edges of the state space of the resulting three-dimensional Markov process. The optimal exercise boundaries of the perpetual American call, put and strangle options are obtained as solutions of arithmetic equations and first-order nonlinear ordinary differential equations
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