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An inverse optimal stopping problem for diffusion processes

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  • Thomas Kruse
  • Philipp Strack

Abstract

Let $X$ be a one-dimensional diffusion and let $g\colon[0,T]\times\mathbb{R}\to\mathbb{R}$ be a payoff function depending on time and the value of $X$. The paper analyzes the inverse optimal stopping problem of finding a time-dependent function $\pi:[0,T]\to\mathbb{R}$ such that a given stopping time $\tau^{\star}$ is a solution of the stopping problem $\sup_{\tau}\mathbb{E}\left[g(\tau,X_{\tau})+\pi(\tau)\right]\,.$ Under regularity and monotonicity conditions, there exists a solution $\pi$ if and only if $\tau^{\star}$ is the first time when $X$ exceeds a time-dependent barrier $b$, i.e. $\tau^{\star}=\inf\left\{ t\ge0\,|\,X_{t}\ge b(t)\right\} \,.$ We prove uniqueness of the solution $\pi$ and derive a closed form representation. The representation is based on an auxiliary process which is a version of the original diffusion $X$ reflected at $b$ towards the continuation region. The results lead to a new integral equation characterizing the stopping boundary $b$ of the stopping problem $\sup_{\tau}\mathbb{E}\left[g(\tau,X_{\tau})\right]$.

Suggested Citation

  • Thomas Kruse & Philipp Strack, 2014. "An inverse optimal stopping problem for diffusion processes," Papers 1406.0209, arXiv.org, revised Aug 2017.
  • Handle: RePEc:arx:papers:1406.0209
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    Cited by:

    1. Marco Buso & Cesare Dosi & Michele Moretto, 2018. "Termination Fees and Contract Design in Public-Private Partnerships," "Marco Fanno" Working Papers 0227, Dipartimento di Scienze Economiche "Marco Fanno".

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