The trap of complacency in predicting the maximum

DOI10.1214/009117906000000638zbMATH Open1120.60044arXivmath/0703805OpenAlexW2117612480MaRDI QIDQ879259FDOQ879259

Authors: Jacques Du Toit, Goran Peskir 

Publication date: 8 May 2007

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

Abstract: Given a standard Brownian motion $B^{mu}=(B_t^{mu}{)}_{0letleT}$ with drift $muinmathbbR$ and letting $S_t^{mu}=ma{x}_{0leslet}{B}_s^{mu}$ for $0letleT$, we consider the optimal prediction problem: [V=inf_{0le au le T}mathsf{E}(B_{ au}^{mu}-S_T^{mu})^2] where the infimum is taken over all stopping times $au$ of $B^{mu}$. Reducing the optimal prediction problem to a parabolic free-boundary problem we show that the following stopping time is optimal: [ au_*=inf {t_*le tle Tmid b_1(t)le S_t^{mu}-B_t^{mu}le b_2(t)}] where $t_{*}in[0,T)$ and the functions $tmapsto{b}_1(t)$ and $tmapsto{b}_2(t)$ are continuous on $[t_{*},T]$ with $b_1(T)=0$ and $b_2(T)=1/2mu$. If $mu>0$, then $b_1$ is decreasing and $b_2$ is increasing on $[t_{*},T]$ with $b_1(t_{*})=b_2(t_{*})$ when $t_{*}e0$. Using local time-space calculus we derive a coupled system of nonlinear Volterra integral equations of the second kind and show that the pair of optimal boundaries $b_1$ and $b_2$ can be characterized as the unique solution to this system. This also leads to an explicit formula for $V$ in terms of $b_1$ and $b_2$. If $mule0$, then $t_{*}=0$ and $b_{2}equiv+infty$ so that $a{u}_{*}$ is expressed in terms of $b_1$ only. In this case $b_1$ is decreasing on $[z_{*},T]$ and increasing on $[0,z_{*})$ for some $z_{*}in[0,T)$ with $z_{*}=0$ if $mu=0$, and the system of two Volterra equations reduces to one Volterra equation. If $mu=0$, then there is a closed form expression for $b_1$. This problem was solved in [Theory Probab. Appl. 45 (2001) 125--136] using the method of time change (i.e., change of variables). The method of time change cannot be extended to the case when $mue0$ and the present paper settles the remaining cases using a different approach.

Full work available at URL: https://arxiv.org/abs/math/0703805

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zbMATH Keywords

Brownian motionoptimal stoppingnonlinear Volterra integral equationoptimal predictionlocal time-space calculus

Mathematics Subject Classification ID

Diffusion processes (60J60) Brownian motion (60J65) Free boundary problems for PDEs (35R35) Systems of nonlinear integral equations (45G15) Stopping times; optimal stopping problems; gambling theory (60G40)

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