Singular optimal strategies for investment with transaction costs (Q1296728)

This paper deals with the following stochastic process \((X,Y)\) satisfying the stochastic differential equation \[ dX(t)=\mu(t) dt+ \sigma(t) dW(t)+ dL(t)- dU(t), \] \[ dY(t)=-(1+\alpha) dL(t)+ (1-\lambda) dU(t) \] and the initial condition \((X(0-),Y(0-))= (x,y).\) Here \((W(t):t\geq 0)\) is a standard Brownian motion. The processes \(\mu(t)\) and \(\sigma(t)\) are assumed to be real. The processes \(L(t)\) and \(U(t)\) are assumed to be right continuous with left limits, nonnegative, nondecreasing and adapted. The quantities \(\alpha\) and \(\lambda\) are two positive constants and \(0<\lambda<1.\) The process \(X(t)\) represents the amount invested in a risky asset at time \(t,\) and \(Y(t)\) represents the amount in a risk-free bank account (with zero interest rate). The real numbers \(\alpha\) and \(\lambda\) account for proportional transaction costs incurred whenever wealth is transferred from one asset to the other. In the paper's control problem, the processes \(\mu, \sigma, L, U\) are considered as control processes in some control set. This control set depends on the investor's wealth in the risky asset. The wealth can be transferred between the two assets and there are charges on all transactions equal to a fixed percentage of the amount transacted. The investor's financial goal is to achieve a total wealth of \(a>0.\) The objective of this paper is to find an optimal strategy to maximize the probability of reaching a total wealth \(a\) before bankruptcy. Under certain conditions on the control sets, an optimal strategy is found that consists of an optimal choice of a risky asset and an optimal choice for the allocation of wealth (buying and selling policies) between the two assets. The paper gives two applications. The first one considers an investment model with one risky asset, which is usually called a stock, and a risk-free bank account. The second one considers a firm, such as a property liability insurance company or a pension management company, having a risk obligation and wishing to achieve a certain financial goal before going bankrupt.