The right time to sell a stock whose price is driven by Markovian noise

Details The right time to sell a stock whose price is driven by Markovian noise The right time to sell a stock whose price is driven by Markovian noise

2005-03-25

arxiv.org/abs/math/0503580v1

Annals of Applied Probability 2004, Vol. 14, No. 4, 2176-2201

Mathematics

Probability

Published at http://dx.doi.org/10.1214/105051604000000747 in the Annals of Applied Probability (http://www.imstat.org/aap/) by

Scientific paper

10.1214/105051604000000747

We consider the problem of finding the optimal time to sell a stock, subject to a fixed sales cost and an exponential discounting rate \rho. We assume that the price of the stock fluctuates according to the equation dY_t=Y_t(\mu dt+\sigma\xi(t) dt), where (\xi(t)) is an alternating Markov renewal process with values in {\pm1}, with an exponential renewal time. We determine the critical value of \rho under which the value function is finite. We examine the validity of the ``principle of smooth fit'' and use this to give a complete and essentially explicit solution to the problem, which exhibits a surprisingly rich structure. The corresponding result when the stock price evolves according to the Black and Scholes model is obtained as a limit case.

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