Pseudo linear pricing rule for utility indifference valuation
Assume a market with a random source given by a \(d\)-dimensional Brownian motion with a traded financial index \(P\), a bank account \(B\) and \(d\) observable but non traded assets \(S^i\). The goal of the paper is to develop a method of pricing and hedging path dependent contingent claims on the non-traded assets. This problem has been widely studied, see for example [\textit{T. R. Bieleck} and \textit{M. Jeanblanc}, in: Indifference pricing: Theory and applications. Princeton, NJ: Princeton University Press. 211--240 (2009; Zbl 1192.91092)], [\textit{C. Frei} and \textit{M. Schweizer}, in: Optimality and risk -- modern trends in mathematical finance. The Kabanov Festschrift. Berlin: Springer. 49--86 (2009; Zbl 1188.91216)], [the first author and \textit{D. Hobson}, in: Indifference pricing: Theory and applications. Princeton, NJ: Princeton University Press. 44--73 (2009; Zbl 1158.91379)] and [\textit{S. Ankirchner} et al., Math. Finance 20, No. 2, 289--312 (2010; Zbl 1217.91178)]. It is known that using utility indifference valuation (Definition 2.2 in the paper) the investor can determine the price of \(\lambda\) units of the contingent claim \(C_t^{\lambda}\) solving a quadratic BSDE (Theorem 2.3). In the paper, an alternative proof from the risk-sensitive control viewpoint is presented. The martingale optimality principle is not used, as in the previous literature, for example in [Ankirchner et al., loc. cit.]. In Theorem 3.1, the main result of the paper, it is shown the utility indifference price \(C^{\lambda}_t\) can be represented as a linear conditional expectation in terms of the unique solution of a functional differential equation, that runs forward in time and it is simpler than the previous BSDE. This gives a remarkable simplification of the representation of \(C^{\lambda}_t\) (Formula 3.3), called pseudo linear pricing rule. The idea of transforming BSDEs to functional differential equations come from [\textit{G. Liang} et al., Ann. Probab. 39, No. 4, 1422--1448 (2011; Zbl 1238.60064)].
scientific article; zbMATH DE number 6348474