On controller-stopper problems with jumps and their applications to indifference pricing of American options

DOI10.1137/120903336zbMATH Open1339.60120arXiv1212.4894OpenAlexW1984770812MaRDI QIDQ2940751FDOQ2940751

Zhou Zhou, Erhan Bayraktar

Publication date: 20 January 2015

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

Abstract: We consider controller-stopper problems in which the controlled processes can have jumps. The global filtration is represented by the Brownian filtration, enlarged by the filtration generated by the jump process. We assume that there exists a conditional probability density function for the jump times and marks given the filtration of the Brownian motion and decompose the global controller-stopper problem into controller-stopper problems with respect to the Brownian filtration, which are determined by a backward induction. We apply our decomposition method to indifference pricing of American options under multiple default risk. The backward induction leads to a system of reflected backward stochastic differential equations (RBSDEs). We show that there exists a solution to this RBSDE system and that the solution provides a characterization of the value function.

Full work available at URL: https://arxiv.org/abs/1212.4894

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zbMATH Keywords

decompositionBrownian motionAmerican optionsjump processesindifference pricingreflected backward stochastic differential equationscontroller-stopper problems

Mathematics Subject Classification ID

Brownian motion (60J65) 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)

Cited In (6)

• HEDGING OF AMERICAN OPTIONS IN ILLIQUID MARKETS WITH PRICE IMPACTS
• Pricing American options for jump diffusions by iterating optimal stopping problems for diffusions
• Impact of time illiquidity in a mixed market without full observation
• LIFETIME CONSUMPTION AND INVESTMENT FOR WORST-CASE CRASH SCENARIOS
• Utility Maximization When Shorting American Options
• Risk-sensitive stopping problems for continuous-time Markov chains

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