On stochastic control problems with higher-order moments

TL;DR

This paper develops methods for solving time-inconsistent stochastic control problems involving higher-order moments, establishing PDE systems and maximum principles for both closed-loop and open-loop Nash equilibria, with applications to linear dynamics.

Contribution

It introduces a novel PDE system for closed-loop Nash equilibrium controls and a maximum principle approach for open-loop controls in higher-order moment problems, addressing time-inconsistency.

Findings

PDE system for closed-loop Nash equilibrium derived

Open-loop equilibrium characterized via forward-backward SDEs

Equivalence of closed-loop and open-loop controls in certain cases

Abstract

In this paper, we focus on a class of time-inconsistent stochastic control problems, where the objective function includes the mean and several higher-order central moments of the terminal value of state. To tackle the time-inconsistency, we seek both the closed-loop and the open-loop Nash equilibrium controls as time-consistent solutions. We establish a partial differential equation (PDE) system for deriving a closed-loop Nash equilibrium control, which does not include the equilibrium value function and is different from the extended Hamilton-Jacobi-Bellman (HJB) equations as in Bj\"ork et al. (Finance Stoch. 21: 331-360, 2017). We show that our PDE system is equivalent to the extended HJB equations that seems difficult to be solved for our higher-order moment problems. In deriving an open-loop Nash equilibrium control, due to the non-separable higher-order moments in the objective function, we make some moment estimates in addition to the standard perturbation argument for developing a maximum principle. Then, the problem is reduced to solving a flow of forward-backward stochastic differential equations. In particular, we investigate linear controlled dynamics and some objective functions affine in the mean. The closed-loop and the open-loop Nash equilibrium controls are identical, which are independent of the state value, random path and the preference on the odd-order central moments. By sending the highest order of central moments to infinity, we obtain the time-consistent solutions to some control problems whose objective functions include some penalty functions for deviation.