Maturity randomization for stochastic control problems

Details Maturity randomization for stochastic control problems Maturity randomization for stochastic control problems

2006-02-21

arxiv.org/abs/math/0602462v1

Annals of Applied Probability 2005, Vol. 15, No. 4, 2575-2605

Mathematics

Probability

Published at http://dx.doi.org/10.1214/105051605000000593 in the Annals of Applied Probability (http://www.imstat.org/aap/) by

Scientific paper

10.1214/105051605000000593

We study a maturity randomization technique for approximating optimal control problems. The algorithm is based on a sequence of control problems with random terminal horizon which converges to the original one. This is a generalization of the so-called Canadization procedure suggested by Carr [Review of Financial Studies II (1998) 597--626] for the fast computation of American put option prices. In addition to the original application of this technique to optimal stopping problems, we provide an application to another problem in finance, namely the super-replication problem under stochastic volatility, and we show that the approximating value functions can be computed explicitly.

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