Investment/consumption problem in illiquid markets with regime-switching

DOI10.1137/120876976zbMATH Open1297.49040arXiv1107.4210OpenAlexW2952762841MaRDI QIDQ3192141FDOQ3192141

Huyên Pham, Paul Gassiat, Fausto Gozzi

Publication date: 26 September 2014

Published in: SIAM Journal on Control and Optimization (Search for Journal in Brave)

Abstract: We consider an illiquid financial market with different regimes modeled by a continuous-time finite-state Markov chain. The investor can trade a stock only at the discrete arrival times of a Cox process with intensity depending on the market regime. Moreover, the risky asset price is subject to liquidity shocks, which change its rate of return and volatility, and induce jumps on its dynamics. In this setting, we study the problem of an economic agent optimizing her expected utility from consumption under a non-bankruptcy constraint. By using the dynamic programming method, we provide the characterization of the value function of this stochastic control problem in terms of the unique viscosity solution to a system of integro-partial differential equations. We next focus on the popular case of CRRA utility functions, for which we can prove smoothness $C^2$ results for the value function. As an important byproduct, this allows us to get the existence of optimal investment/consumption strategies characterized in feedback forms. We analyze a convergent numerical scheme for the resolution to our stochastic control problem, and we illustrate finally with some numerical experiments the effects of liquidity regimes in the investor's optimal decision.

Full work available at URL: https://arxiv.org/abs/1107.4210

zbMATH Keywords

Markov chainoptimal consumptionstochastic controlviscosity solutionsdynamic programming methodregime-switching modelsliquidity effectsintegro-partial differential system

Mathematics Subject Classification ID

Auctions, bargaining, bidding and selling, and other market models (91B26) Integro-partial differential equations (35R09) Existence of optimal solutions to problems involving randomness (49J55) Optimality conditions for problems involving relations other than differential equations (49K21) Optimality conditions for problems involving randomness (49K45) Dynamic programming in optimal control and differential games (49L20) Viscosity solutions to Hamilton-Jacobi equations in optimal control and differential games (49L25) Financial applications of other theories (91G80) Optimal stochastic control (93E20)

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• Expected log-utility maximization under incomplete information and with Cox-process observations
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