Optimal investment under multiple defaults risk: a BSDE-decomposition approach (Q1948694)

The authors address an investment problem in asset portfolios subject to defaults and contagion risk. The global market information is formulated as a progressive enlargement of a default-free Brownian filtration, and the dependence of default times is modeled by a conditional density hypothesis. In this Itô process model, they give a decomposition of the corresponding stochastic control problem into stochastic control problems in the default-free filtration, which are determined in a backward induction. The dynamic programming method leads to a backward recursive system of quadratic backward stochasic differential equations (BSDEs) in Brownian filtration. The main result proves, under fairly general conditions, the existence and uniqueness of a solution to this system, which characterizes explicity the value function and optimal strategies to the optimal investment problem. Finally, the authors illustrate their solution approach with some numerical tests emphasizing the impact of default intensities, loss or gain at defaults and correlation between assets. It should be noted that this decomposition approach provides a new perspective for solving quadratic BSDEs with a finite number of jumps.