Comparisons for backward stochastic differential equations on Markov chains and related no-arbitrage conditions (Q2268728)

BSDEs with an underlying finite state Markov chain as a stochastic process form a viable alternative to BSDEs based on Brownian motions and Brownian motions with Poisson jumps. The authors have given closed form solutions to linear BSDEs on Markov chains, and then have used these to develop a comparison theorem for the solutions. These BSDEs allow for very delicate modelling of no arbitrage conditions. In particular, they allow no arbitrage only to be required on a subset of all possible terminal conditions, but the pricing rule to allow arbitrage outside this set. This is in contrast to BSDEs based on Brownian motion, where the comparison theorem guarantees no arbitrage in all cases. They have drawn a connection between the exclusion of arbitrage and the presence of a balanced driver F, a condition which can be understood as an infinitesimal no-arbitrage condition. They have also discussed the geometry of these BSDEs and the relation to no arbitrage conditions. Finally, they have shown key properties which can be used when developing nonlinear evaluations and risk measures from these BSDEs. The added requirements of the theorem help them to distinguish precisely what is needed for each of these properties to hold which may prove useful when considering other models.