Discretionary stopping of stochastic differential equations with generalised drift

DOI10.1214/19-EJP377zbMATH Open1427.60071arXiv1903.03834OpenAlexW2992546962MaRDI QIDQ2279339FDOQ2279339

Authors: Mihail Zervos, Neofytos Rodosthenous, Pui Chan Lon, Thomas Bernhardt 

Publication date: 12 December 2019

Published in: Electronic Journal of Probability (Search for Journal in Brave)

Abstract: We consider the problem of optimally stopping a general one-dimensional stochastic differential equation (SDE) with generalised drift over an infinite time horizon. First, we derive a complete characterisation of the solution to this problem in terms of variational inequalities. In particular, we prove that the problem's value function is the difference of two convex functions and satisfies an appropriate variational inequality in the sense of distributions. We also establish a verification theorem that is the strongest one possible because it involves only the optimal stopping problem's data. Next, we derive the complete explicit solution to the problem that arises when the state process is a skew geometric Brownian motion and the reward function is the one of a financial call option. In this case, we show that the optimal stopping strategy can take several qualitatively different forms, depending on parameter values. Furthermore, the explicit solution to this special case reveals that the so-called "principle of smooth fit" does not hold in general for this type of optimal stopping problems in standard senses that this can be formulated.

Full work available at URL: https://arxiv.org/abs/1903.03834

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zbMATH Keywords

optimal stoppingskew Brownian motionvariational inequalitiesperpetual American optionsstochastic differential equations with generalised drift

Mathematics Subject Classification ID

Diffusion processes (60J60) Stopping times; optimal stopping problems; gambling theory (60G40) Local time and additive functionals (60J55) Financial applications of other theories (91G80)

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Cited In (3)

• Martingale approach to stochastic control with discretionary stopping
• Stopping spikes, continuation bays and other features of optimal stopping with finite-time horizon
• The trap of complacency in predicting the maximum

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