Forward–Backward Stochastic Differential Games and Stochastic Control under Model Uncertainty

Bernt Øksendal () and Agnès Sulem ()
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Bernt Øksendal: Center of Mathematics for Applications (CMA)
Agnès Sulem: INRIA Paris-Rocquencourt

Journal of Optimization Theory and Applications, 2014, vol. 161, issue 1, No 2, 22-55

Abstract: Abstract We study optimal stochastic control problems with jumps under model uncertainty. We rewrite such problems as stochastic differential games of forward–backward stochastic differential equations. We prove general stochastic maximum principles for such games, both in the zero-sum case (finding conditions for saddle points) and for the nonzero sum games (finding conditions for Nash equilibria). We then apply these results to study robust optimal portfolio-consumption problems with penalty. We establish a connection between market viability under model uncertainty and equivalent martingale measures. In the case with entropic penalty, we prove a general reduction theorem, stating that a optimal portfolio-consumption problem under model uncertainty can be reduced to a classical portfolio-consumption problem under model certainty, with a change in the utility function, and we relate this to risk sensitive control. In particular, this result shows that model uncertainty increases the Arrow–Pratt risk aversion index.

Keywords: Forward–backward SDEs; Stochastic differential games; Maximum principle; Model uncertainty; Robust control; Viability; Optimal portfolio; Optimal consumption; Jump diffusions (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (5)

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DOI: 10.1007/s10957-012-0166-7

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