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Stochastic Calculus II Exercise Sheet 7

This document provides exercises for a stochastic calculus class, assigning problems 2, 3, and 4 to be completed and turned in on April 25th. Exercise 1 involves minimizing a cost function given stock dynamics through stochastic control. Exercises 2 and 3 involve maximizing logarithmic utility of terminal wealth and consumption respectively given stock dynamics through stochastic control. Exercise 4 involves maximizing expected terminal wealth to the power of γ given stock dynamics through two risky assets and stochastic control.

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76 views

Stochastic Calculus II Exercise Sheet 7

This document provides exercises for a stochastic calculus class, assigning problems 2, 3, and 4 to be completed and turned in on April 25th. Exercise 1 involves minimizing a cost function given stock dynamics through stochastic control. Exercises 2 and 3 involve maximizing logarithmic utility of terminal wealth and consumption respectively given stock dynamics through stochastic control. Exercise 4 involves maximizing expected terminal wealth to the power of γ given stock dynamics through two risky assets and stochastic control.

Uploaded by

DIA
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Stochastic Calculus II

Exercise Sheet 7
Prof. D. Filipović, E. Hapnes

Please hand in your solutions to exercises 2, 3 and 4 on Wednesday 25.04.2018 at


the beginning of the lecture.

Classroom exercise
Exercise 1: In this exercise we solve the problem to minimize
h RT 2 2
i
E e 0 ut dt+XT ,

given the dynamics dXt = (aXt + ut ) dt + σ dWt , X0 = x0 ∈ R, where a, σ > 0 and the control
process is u.

(a) Derive the following HJB equation for this problem:


1
∂t V (t, x) + σ 2 ∂xx V (t, x) + inf u2 V (t, x) + (ax + u)∂x V (t, x) = 0

2 u
2
V (T, x) = ex .

2 +B(t)
(b) With the ansatz V (t, x) = eA(t)x for some functions A(·) and B(·), find the optimal
control law.
Assignment
Exercise 2: Consider the following problem of maximizing the logarithmic utility of the ter-
minal wealth
E [log(XT )] ,
given the wealth dynamics

dXt = Xt [((1 − πt )r + πt α) dt + πt σ dWt ] , X0 = x0 > 0,

where W is a Brownian motion, r, α, σ > 0, and the control process is πt .


(a) Derive the HJB equation for this problem.
(b) Show that the optimal value function V is the solution of the following boundary value
problem
1 (r − α)2 (∂x V (t, x))2
∂t V (t, x) + rx∂x V (t, x) − = 0,
2 σ 2 ∂xx V (t, x)
V (T, x) = log(x).

(c) With the ansatz V (t, x) = log (A(t)x) for an appropriate function A, solve this boundary
value problem.
(d) Find the optimal control law.
10
3
points

Exercise 3: Consider the following problem of maximizing logarithmic utility


Z T 
E log(ct ) dt + log(XT ) ,
0

given the wealth dynamics

dXt = Xt ((1 − πt )r + πt α) dt − ct dt + πt Xt σ dWt , X0 = x0 > 0,

where W is a Brownian motion, r, α, σ > 0, and the control processes are π, c under the
constraints that ct ≥ 0 for all t ≥ 0. With the ansatz V (t, x) = A(t) + B(t) log(x) for some
functions A(·) and B(·), find the optimal control law.
10
3
points

Exercise 4: In this exercise we solve the problem to maximize

E [XTγ ] ,

where γ ∈ (0, 1). There are two risky assets with price dynamics dPit = µi Pit dt + σi Pit dWit for
i ∈ {1, 2}. Asset 1 is riskier than asset 2 with µ1 > µ2 and σ1 > σ2 . The two Brownian motions
are independent. The investor has to invest a fraction πt in asset 1 and (1 − πt ) in asset 2. The
wealth at time t is given by Xt .

(a) Find the dynamics of Xt .


(b) Write down the HJB-equation for the maximization problem.
(c) Use the ansatz V (t, Xt ) = eλ(T −t) Xtγ where λ is a constant. Solve the maximization problem
and find πt and λ.
10
3
points

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