Backward SDEs for control with partial information. (18th February 2018)

• Record Type: Journal Article
• Authors: Papanicolaou, Andrew
• Is Part Of: Mathematical finance. Volume 29:Number 1(2019)
• Page Start: 208
• Page End: 248
• Publication Date: 2018-02-18
• Subjects: backward stochastic differential equations -- non‐Markov control -- partial information -- portfolio optimization; Business mathematics -- Periodicals; 332
• DOI: 10.1111/mafi.12174
• Languages: English
• ISSNs: 0960-1627

Abstract

Abstract: This paper considers a non‐Markov control problem arising in a financial market where asset returns depend on hidden factors. The problem is non‐Markov because nonlinear filtering is required to make inference on these factors, and hence the associated dynamic program effectively takes the filtering distribution as one of its state variables. This is of significant difficulty because the filtering distribution is a stochastic probability measure of infinite dimension, and therefore the dynamic program has a state that cannot be differentiated in the traditional sense. This lack of differentiability means that the problem cannot be solved using a Hamilton–Jacobi–Bellman equation. This paper will show how the problem can be analyzed and solved using backward stochastic differential equations, with a key tool being the problem's dual formulation.