Optimal pricing barriers in a regulated market using reflected diffusion processes

Zheng Han, Yaozhong Hu, Chihoon Lee

Research output: Contribution to journalArticlepeer-review

15 Scopus citations

Abstract

We consider a class of one-dimensional (1D) reflected stochastic differential equations (SDEs). Such reflected SDE models arise as the key approximating processes in a regulated financial market system, and our main goal is to determine the set of optimal pricing barriers. We consider the running cost associated with the deviation of the process from the desired target level, and also the control cost from the interventions in an effort to keep the process inside the boundaries. Both a long-time average (ergodic) cost criterion and an infinite horizon discount cost criterion, where the discount factor is allowed to vary from one period to another, are studied, with numerical examples illustrating our main results.

Original languageEnglish
Pages (from-to)639-647
Number of pages9
JournalQuantitative Finance
Volume16
Issue number4
DOIs
StatePublished - 2 Apr 2016

Keywords

  • Ergodic cost
  • Infinite horizon discount cost
  • Optimal barriers
  • Reflected stochastic differential equations
  • Regulated (controlled) market

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