Time-consistent conditional expectation under probability distortion

DOI10.1287/MOOR.2020.1101MaRDI QIDQ4958560zbMATH OpenOpenAlexFDO

Authors

Publication date 14 September 2021

Published in Mathematics of Operations Research (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/1809.08262

zbMATH Keywords

nonlinear expectationprobability distortiontime inconsistency

Mathematics Subject Classification ID

Applications of stochastic analysis (to PDEs, etc.) (60H30) Optimal stochastic control (93E20)

Abstract: We introduce a new notion of conditional nonlinear expectation under probability distortion. Such a distorted nonlinear expectation is not sub-additive in general, so it is beyond the scope of Peng's framework of nonlinear expectations. A more fundamental problem when extending the distorted expectation to a dynamic setting is time-inconsistency, that is, the usual "tower property" fails. By localizing the probability distortion and restricting to a smaller class of random variables, we introduce a so-called distorted probability and construct a conditional expectation in such a way that it coincides with the original nonlinear expectation at time zero, but has a time-consistent dynamics in the sense that the tower property remains valid. Furthermore, we show that in the continuous time model this conditional expectation corresponds to a parabolic differential equation whose coefficient involves the law of the underlying diffusion. This work is the first step towards a new understanding of nonlinear expectations under probability distortion, and will potentially be a helpful tool for solving time-inconsistent stochastic optimization problems.

Recommendations

• Optimal Stopping Under Probability Distortions
• Sensitivity analysis of nonlinear behavior with distorted probability
• Conditional expectiles, time consistency and mixture convexity properties

Cites work

• A survey of time consistency of dynamic risk measures and dynamic performance measures in discrete time: LM-measure perspective
• Advances in prospect theory: cumulative representation of uncertainty
• Better than dynamic mean-variance: time inconsistency and free cash flow stream
• Dynamic approaches for some time-inconsistent optimization problems
• General stopping behaviors of naïve and noncommitted sophisticated agents, with application to probability distortion
• scientific article; zbMATH DE number 1066320 (Why is no real title available?)
• scientific article; zbMATH DE number 5499205 (Why is no real title available?)
• Mathematicalising behavioural finance
• Mean-variance portfolio optimization with state-dependent risk aversion
• Predictable forward performance processes: the binomial case
• Prospect Theory: An Analysis of Decision under Risk
• Stochastic Partial Differential Equations and Portfolio Choice
• The golden rule when preferences are time inconsistent
• The Probability Weighting Function
• Time consistency of dynamic risk measures in markets with transaction costs
• Time-inconsistent optimal control problems and the equilibrium HJB equation
• Time-inconsistent stochastic linear-quadratic control
• User’s guide to viscosity solutions of second order partial differential equations

Cited in

(6)

• Now decision theory
• Distorted probability operator for dynamic portfolio optimization in times of socio-economic crisis
• Me, myself and I: a general theory of non-Markovian time-inconsistent stochastic control for sophisticated agents
• Random distortion risk measures
• Time-consistent asset allocation for risk measures in a Lévy market
• Time consistency of dynamic risk measures and dynamic performance measures generated by distortion functions

This page was built for publication: Time-consistent conditional expectation under probability distortion

Report a bug (only for logged in users!)Click here to report a bug for this page (MaRDI item Q4958560)