Minimal Kullback–Leibler Divergence for Constrained Lévy–Itô Processes

DOI10.1137/23M1555697MaRDI QIDQ6202389FDOQ6202389

Authors Sebastian Jaimungal, Silvana M. Pesenti, Leandro Sánchez-Betancourt 

Publication date 26 March 2024

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

Full work available at URL https://arxiv.org/abs/2206.14844

zbMATH Keywords

Kullback-Leibler divergencerisk managementoptimal probability measurescontrolled Lévy-Itô processes

Mathematics Subject Classification ID

Processes with independent increments; Lévy processes (60G51) Dynamic programming (90C39)

Abstract: Given an n-dimensional stochastic process X driven by P-Brownian motions and Poisson random measures, we seek the probability measure Q, with minimal relative entropy to P, such that the Q-expectations of some terminal and running costs are constrained. We prove existence and uniqueness of the optimal probability measure, derive the explicit form of the measure change, and characterise the optimal drift and compensator adjustments under the optimal measure. We provide an analytical solution for Value-at-Risk (quantile) constraints, discuss how to perturb a Brownian motion to have arbitrary variance, and show that pinned measures arise as a limiting case of optimal measures. The results are illustrated in a risk management setting -- including an algorithm to simulate under the optimal measure -- where an agent seeks to answer the question: what dynamics are induced by a perturbation of the Value-at-Risk and the average time spent below a barrier on the reference process?

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