CONIC TRADING IN A MARKOVIAN STEADY STATE

Dilip B. Madan (), Martijn Pistorius and Wim Schoutens
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Dilip B. Madan: Department of Finance, Robert H. Smith School of Business, University of Maryland, College Park, MD 20742, USA
Martijn Pistorius: #x2020;Department of Mathematics, Robert H. Smith School of Business, Imperial College, Kensington, London SW72AJ, UK
Wim Schoutens: #x2021;Department of Mathematics, K.U. Leuven, Oude Markt 13, 3000 Leuven, Belgium

International Journal of Theoretical and Applied Finance (IJTAF), 2017, vol. 20, issue 02, 1-22

Abstract: Trading strategies are valued using nonlinear conditional expectations based on concave probability distortions. They are also referred to as expectation with respect to a nonadditive probability. The nonadditive probability attains conservatism by exaggerating upwards the probabilities of tail loss events and simultaneously deflating the probabilities of tail gain events. Fixed points for value and policy iterations are obtained when probabilities are distorted and they fail to exist for classical linear or additive expectations. Illustrations are provided for Markovian systems in one, two and five dimensions. Trading positions are seen to balance prediction rewards against the demands for hedging value functions.

Keywords: Probability distortion; contraction mapping; fixed points; quantization (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (1)

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DOI: 10.1142/S0219024917500108

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