The trap of complacency in predicting the maximum

DOI10.1214/009117906000000638MaRDI QIDQ879259zbMATHOpenAlexFDO

Authors Jacques Du Toit, Goran Peskir

Publication date 8 May 2007

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

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

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)

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 $t_{\ast }in[0,T)$ and the functions $tmapsto{b}_1(t)$ and $tmapsto{b}_2(t)$ are continuous on $[t_{\ast },T]$ 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 $[t_{\ast },T]$ with $b_1(t_{\ast })=b_2(t_{\ast })$ when $t_{\ast }e0$. 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 $t_{\ast }=0$ and $b_{2}equiv+infty$ so that $a{u}_{\ast }$ is expressed in terms of $b_1$ only. In this case $b_1$ is decreasing on $[z_{\ast },T]$ and increasing on $[0,z_{\ast })$ for some $z_{\ast }in[0,T)$ with $z_{\ast }=0$ 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.

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Cited in

(35)

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• Three-dimensional Brownian motion and the golden ratio rule
• Optimal detection of a hidden target: the median rule
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• The optimal stopping problem concerned with ultimate maximum of a Lévy process
• Minimax perfect stopping rules for selling an asset near its ultimate maximum
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• The British call option
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• Time-randomized stopping problems for a family of utility functions
• The British asset-or-nothing put option
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• The British lookback option with fixed strike
• Predicting the Time of the Ultimate Maximum for Brownian Motion with Drift
• Predicting the Supremum: Optimality of ‘Stop at Once or Not at All’
• The British Asian option
• Optimal selling rules for monetary invariant criteria: tracking the maximum of a portfolio with negative drift
• The British Russian Option
• Optimal prediction of the ultimate maximum of Brownian motion
• On-line VWAP Trading Strategies
• On the optimal exercise boundaries of swing put options

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