Optimal control of Volterra integral diffusions and application to contract theory

TL;DR

This paper develops a novel framework for the optimal control of stochastic Volterra integral equations using Sobolev space lifting and viscosity solutions, with applications to contract theory and principal-agent problems.

Contribution

It introduces a Sobolev space approach and viscosity solution theory for controlling non-convolution type Volterra equations, expanding the toolkit for stochastic control problems.

Findings

Characterized the value function as a unique solution to a parabolic PDE on Sobolev space.

Provided applications to time-inconsistent principal-agent problems.

Introduced a new Markovian approximation for Volterra dynamics.

Abstract

This paper focuses on the optimal control of a class of stochastic Volterra integral equations. Here the coefficients are regular and not assumed to be of convolution type. We show that, under mild regularity assumptions, these equations can be lifted in a Sobolev space, whose Hilbertian structure allows us to attack the problem through a dynamic programming approach. We are then able to use the theory of viscosity solutions on Hilbert spaces to characterise the value function of the control problem as the unique solution of a parabolic equation on Sobolev space. We provide applications and examples to illustrate the usefulness of our theory, in particular for a certain class of time inconsistent principal agent problems. As a byproduct of our analysis, we introduce a new Markovian approximation for Volterra type dynamics.