Shadow prices, fractional Brownian motion, and portfolio optimisation under transaction costs (Q1691449)

This paper deals with the existence of a shadow price for portfolio optimization under transaction costs in the fractional Black-Scholes model. This is a semimartingale price process \(\widehat{S} = (\widehat{S}_t)_{0\leq t \leq T}\) taking values in the bid-ask spread. It is proved that a shadow price exists for the fractional Black-Scholes model for arbitrary utility functions \(U : (0,\infty) \rightarrow \mathbb{R}\) satisfying the condition of reasonable asymptotic elasticity. In a previous paper [Math. Finance 27, No. 3, 623--658 (2017; Zbl 1396.91684)], the authors established, for utility functions \(U : (0,\infty) \rightarrow \mathbb{R}\), the existence of a shadow price under the assumption that \(S\) is continuous and satisfies the condition of ``no unbounded profit with bounded risk'' (NUBPR) without transaction costs. To ensure the existence of a shadow price in the setting of this new paper, it is sufficient to exclude that the optimal trading strategy takes the maximal leverage. This is done in the first main result of the paper by imposing the condition of ``two way crossing'' (TWC). The significance of the condition TWC in this first main theorem is that it holds in the fractional Black-Scholes model because of the fact that fractional Brownian motion satisfies a law of iterated logarithm at stopping times. This gives the existence of shadow prices for the fractional Black-Scholes model and utility functions that are bounded from above. To extend this to utility functions that are unbounded from above, the authors need to ensure that the problem is well posed and therefore they have to establish that the indirect utility is finite. Since fractional Brownian motion is neither a Markov process nor a semimartingale, different tools than in the frictionless setting are needed in order to achieve this result. This paper uses the fact that in the presence of transaction costs any trading can only be profitable if there is a sufficient price movement. Exploiting estimates on Gaussian processes, it is possible to bound the expected gains from trading by establishing exponential and Gaussian moments of the fluctuations of fractional Brownian motion of size \(\delta > 0\) and therefore to obtain the finiteness of indirect utility for any utility function \(U : (0,\infty) \rightarrow \mathbb{R}\). This allows one to deduce the existence of a shadow price for the fractional Black-Scholes model and an arbitrary utility function \(U : (0,\infty) \rightarrow \mathbb{R}\) satisfying the condition of reasonable asymptotic elasticity. This last result is the second main contribution of the paper and a fairly complete answer to the existence of a shadow price.