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Malliavin calculus method for asymptotic expansion of dual control problems


  • Michael Monoyios


We develop a technique based on Malliavin-Bismut calculus ideas, for asymptotic expansion of dual control problems arising in connection with exponential indifference valuation of claims, and with minimisation of relative entropy, in incomplete markets. The problems involve optimisation of a functional of Brownian paths on Wiener space, with the paths perturbed by a drift involving the control. In addition there is a penalty term in which the control features quadratically. The drift perturbation is interpreted as a measure change using the Girsanov theorem, leading to a form of the integration by parts formula in which a directional derivative on Wiener space is computed. This allows for asymptotic analysis of the control problem. Applications to incomplete It\^o process markets are given, in which indifference prices are approximated in the low risk aversion limit. We also give an application to identifying the minimal entropy martingale measure as a perturbation to the minimal martingale measure in stochastic volatility models.

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  • Michael Monoyios, 2012. "Malliavin calculus method for asymptotic expansion of dual control problems," Papers 1209.6497,, revised Oct 2013.
  • Handle: RePEc:arx:papers:1209.6497

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    References listed on IDEAS

    1. Sara Biagini & Marco Frittelli, 2007. "The supermartingale property of the optimal wealth process for general semimartingales," Finance and Stochastics, Springer, vol. 11(2), pages 253-266, April.
    2. Stefan Ankirchner & Gregor Heyne, 2012. "Cross hedging with stochastic correlation," Finance and Stochastics, Springer, vol. 16(1), pages 17-43, January.
    3. Vicky Henderson & Gechun Liang, 2011. "A Multidimensional Exponential Utility Indifference Pricing Model with Applications to Counterparty Risk," Papers 1111.3856,, revised Sep 2015.
    4. Marco Frittelli, 2000. "The Minimal Entropy Martingale Measure and the Valuation Problem in Incomplete Markets," Mathematical Finance, Wiley Blackwell, vol. 10(1), pages 39-52.
    5. Becherer, Dirk, 2003. "Rational hedging and valuation of integrated risks under constant absolute risk aversion," Insurance: Mathematics and Economics, Elsevier, vol. 33(1), pages 1-28, August.
    6. Michael Monoyios, 2004. "Performance of utility-based strategies for hedging basis risk," Quantitative Finance, Taylor & Francis Journals, vol. 4(3), pages 245-255.
    7. Vicky Henderson, 2002. "Valuation Of Claims On Nontraded Assets Using Utility Maximization," Mathematical Finance, Wiley Blackwell, vol. 12(4), pages 351-373.
    8. Kallsen Jan & Rheinländer Thorsten, 2011. "Asymptotic utility-based pricing and hedging for exponential utility," Statistics & Risk Modeling, De Gruyter, vol. 28(1), pages 17-36, March.
    9. Kramkov, D. & Sîrbu, M., 2007. "Asymptotic analysis of utility-based hedging strategies for small number of contingent claims," Stochastic Processes and their Applications, Elsevier, vol. 117(11), pages 1606-1620, November.
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    Cited by:

    1. Cl'ement M'enass'e & Peter Tankov, 2015. "Asymptotic indifference pricing in exponential L\'evy models," Papers 1502.03359,, revised Feb 2015.
    2. repec:spr:finsto:v:22:y:2018:i:2:d:10.1007_s00780-017-0353-3 is not listed on IDEAS
    3. Benedetti, Giuseppe & Campi, Luciano, 2016. "Utility indifference valuation for non-smooth payoffs with an application to power derivatives," LSE Research Online Documents on Economics 63016, London School of Economics and Political Science, LSE Library.
    4. Julio Backhoff Veraguas & Francisco Silva, 2015. "Sensitivity analysis for expected utility maximization in incomplete Brownian market models," Papers 1504.02734,, revised Feb 2017.
    5. Kasper Larsen & Oleksii Mostovyi & Gordan v{Z}itkovi'c, 2014. "An expansion in the model space in the context of utility maximization," Papers 1410.0946,, revised Aug 2016.

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