Non-homogeneous stochastic LQ control with regime switching and random coefficients

TL;DR

This paper develops explicit solutions for a complex stochastic LQ control problem with regime switching and random coefficients, using advanced BSDE techniques, and applies it to asset-liability management.

Contribution

It introduces a new linear BSDE with unbounded coefficients and proves existence and uniqueness, expanding the theory of stochastic LQ control with regime switching.

Findings

Explicit optimal control and value are derived.

Existence and uniqueness of solutions are established.

Application to asset-liability management demonstrates practical relevance.

Abstract

This paper is concerned with a general non-homogeneous stochastic linear quadratic (LQ) control problem with regime switching and random coefficients. We obtain the explicit optimal state feedback control and optimal value for this problem in terms of two systems of backward stochastic differential equations (BSDEs): one is the famous stochastic Riccati equation and the other one is a new linear multi-dimensional BSDE with all coefficients being unbounded. The existence and uniqueness of the solutions to these two systems of BSDEs are proved by means of BMO martingales and contraction mapping method. At last, the theory is applied to study an asset-liability management problem under the mean-variance criteria.