Differentiability of quadratic BSDEs generated by continuous martingales
AbstractIn this paper we consider a class of BSDEs with drivers of quadratic growth, on a stochastic basis generated by continuous local martingales. We first derive the Markov property of a forward--backward system (FBSDE) if the generating martingale is a strong Markov process. Then we establish the differentiability of a FBSDE with respect to the initial value of its forward component. This enables us to obtain the main result of this article, namely a representation formula for the control component of its solution. The latter is relevant in the context of securitization of random liabilities arising from exogenous risk, which are optimally hedged by investment in a given financial market with respect to exponential preferences. In a purely stochastic formulation, the control process of the backward component of the FBSDE steers the system into the random liability and describes its optimal derivative hedge by investment in the capital market, the dynamics of which is given by the forward component.
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Bibliographic InfoPaper provided by arXiv.org in its series Papers with number 0907.0941.
Date of creation: Jul 2009
Date of revision: Mar 2012
Publication status: Published in Annals of Applied Probability 2012, Vol. 22, No. 1, 285-336
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