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arXiv · 1303.2950

Dynamic Credit Investment in Partially Observed Markets

Agostino Capponi·Jose Enrique Figueroa Lopez·Andrea Pascucci
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Abstract

We consider the problem of maximizing expected utility for a power investor who can allocate his wealth in a stock, a defaultable security, and a money market account. The dynamics of these security prices are governed by geometric Brownian motions modulated by a hidden continuous time finite state Markov chain. We reduce the partially observed stochastic control problem to a complete observation risk sensitive control problem via the filtered regime switching probabilities. We separate the latter into pre-default and post-default dynamic optimization subproblems, and obtain two coupled Hamilton-Jacobi-Bellman (HJB) partial differential equations. We prove existence and uniqueness of a globally bounded classical solution to each HJB equation, and give the corresponding verification theorem. We provide a numerical analysis showing that the investor increases his holdings in stock as the filter probability of being in high growth regimes increases, and decreases his credit risk exposure when the filter probability of being in high default risk regimes gets larger.

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Agostino Capponi, Jose Enrique Figueroa Lopez, Andrea Pascucci. 2014-06-02. Dynamic Credit Investment in Partially Observed Markets. https://arxiv.org/abs/1303.2950

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