An exact connection between two solvable SDEs and a nonlinear utility stochastic PDE

DOI10.1137/10081143XMaRDI QIDQ2873147zbMATHOpenAlexFDO

Authors Nicole El Karoui, Mohamed Mrad

Publication date 23 January 2014

Published in SIAM Journal on Financial Mathematics (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/1004.5191

zbMATH Keywords

stochastic partial differential equationsdualityportfolio optimizationoptimal portfoliostochastic flowsminimal martingale measureperformance criteriaforward utilityconsistent utilityhorizon-unbiased utilityprogressive utility

Mathematics Subject Classification ID

Random fields (60G60) Stochastic partial differential equations (aspects of stochastic analysis) (60H15) Portfolio theory (91G10) Utility theory (91B16) Stochastic ordinary differential equations (aspects of stochastic analysis) (60H10) Applications of stochastic analysis (to PDEs, etc.) (60H30) Financial applications of other theories (91G80) Optimal stochastic control (93E20)

Abstract: Motivated by the work of Musiela and Zariphopoulou cite{zar-03}, we study the It^o random fields which are utility functions $U(t,x)$ for any $(omega,t)$. The main tool is the marginal utility $U_x(t,x)$ and its inverse expressed as the opposite of the derivative of the Fenchel conjuguate $U(t,y)$. Under regularity assumptions, we associate a $SDE(mu,sigma)$ and its adjoint SPDE$(mu,sigma)$ in divergence form whose $U_x(t,x)$ and its inverse $-U_y(t,y)$ are monotonic solutions. More generally, special attention is paid to rigorous justification of the dynamics of inverse flow of SDE. So that, we are able to extend to the solution of similar SPDEs the decomposition based on the solutions of two SDEs and their inverses. The second part is concerned with forward utilities, consistent with a given incomplete financial market, that can be observed but given exogenously to the investor. As in cite{zar-03}, market dynamics are considered in an equilibrium state, so that the investor becomes indifferent to any action she can take in such a market. After having made explicit the constraints induced on the local characteristics of consistent utility and its conjugate, we focus on the marginal utility SPDE by showing that it belongs to the previous family of SPDEs. The associated two SDE's are related to the optimal wealth and the optimal state price density, given a pathwise explicit representation of the marginal utility. This new approach addresses several issues with a new perspective: dynamic programming principle, risk tolerance properties, inverse problems. Some examples and applications are given in the last section.

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Cited in

(32)

• Predictable forward performance processes: Infrequent evaluation and applications to human‐machine interactions
• Optimal investment in defined contribution pension schemes with forward utility preferences
• Dynamic approaches for some time-inconsistent optimization problems
• Asymptotic analysis of forward performance processes in incomplete markets and their ill-posed HJB equations
• Time-consistent pension policy with minimum guarantee and sustainability constraint
• Pricing and hedging equity-linked life insurance contracts beyond the classical paradigm: the principle of equivalent forward preferences
• Mixture of consistent stochastic utilities and \textit{a priori} randomness
• Stochastic partial differential equations with singular terminal condition
• Horizon-unbiased investment with ambiguity
• Construction of a class of forward performance processes in stochastic factor models, and an extension of Widder's theorem
• Recover dynamic utility from observable process: application to the economic equilibrium
• \(G\)-forward performance process and representation of homothetic case via ergodic quadratic \(G\)-BSDE
• Bi-revealed utilities in a defaultable universe: a new point of view on consumption
• Optimal investment and consumption with forward preferences and uncertain parameters
• Forward utility and market adjustments in relative investment-consumption games of many players
• Competition in fund management and forward relative performance criteria
• Evolution of the Arrow-Pratt measure of risk-tolerance for predictable forward utility processes
• Representation of Homothetic Forward Performance Processes in Stochastic Factor Models via Ergodic and Infinite Horizon BSDE
• Deep learning scheme for forward utilities using ergodic BSDEs
• On Regularity of Primal and Dual Dynamic Value Functions Related to Investment Problems and Their Representations as Backward Stochastic PDE Solutions
• Convergence rate of strong approximations of compound random maps, application to SPDEs
• Forward rank‐dependent performance criteria: Time‐consistent investment under probability distortion
• Black's inverse investment problem and forward criteria with consumption
• An ergodic BSDE approach to forward entropic risk measures: representation and large-maturity behavior
• Predictable forward performance processes: the binomial case
• Dynamic utility and related nonlinear SPDEs driven by Lévy noise
• Consistent utility of investment and consumption: a forward/backward SPDE viewpoint
• Optimal contract for a fund manager with capital injections and endogenous trading constraints
• Itô-Wentzell-Lions formula for measure dependent random fields under full and conditional measure flows
• Forward indifference valuation for dynamically incoming projects
• Mean field and \(n\)-player games in Ito-diffusion markets under forward performance criteria
• Optimal liquidation with dynamic parameter updating: a forward approach

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