Optimal arbitrage under model uncertainty

DOI10.1214/10-AAP755zbMATH Open1239.60057arXiv1202.2999OpenAlexW3099391567MaRDI QIDQ657697FDOQ657697

Ioannis Karatzas, Daniel Fernholz

Publication date: 10 January 2012

Published in: The Annals of Applied Probability (Search for Journal in Brave)

Abstract: In an equity market model with "Knightian" uncertainty regarding the relative risk and covariance structure of its assets, we characterize in several ways the highest return relative to the market that can be achieved using nonanticipative investment rules over a given time horizon, and under any admissible configuration of model parameters that might materialize. One characterization is in terms of the smallest positive supersolution to a fully nonlinear parabolic partial differential equation of the Hamilton--Jacobi--Bellman type. Under appropriate conditions, this smallest supersolution is the value function of an associated stochastic control problem, namely, the maximal probability with which an auxiliary multidimensional diffusion process, controlled in a manner which affects both its drift and covariance structures, stays in the interior of the positive orthant through the end of the time-horizon. This value function is also characterized in terms of a stochastic game, and can be used to generate an investment rule that realizes such best possible outperformance of the market.

Full work available at URL: https://arxiv.org/abs/1202.2999

zbMATH Keywords

model uncertaintystochastic controlstochastic gameminimal solutionsrobust portfolio choicearbitragefully nonlinear parabolic equationsmaximal containment probability

Mathematics Subject Classification ID

Stochastic partial differential equations (aspects of stochastic analysis) (60H15) Applications of Brownian motions and diffusion theory (population genetics, absorption problems, etc.) (60J70) Maximum principles in context of PDEs (35B50) Martingales with continuous parameter (60G44) Financial applications of other theories (91G80)

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