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Discounted optimal stopping problems in continuous hidden Markov models

Gapeev, Pavel V. (2021) Discounted optimal stopping problems in continuous hidden Markov models. Stochastics: an International Journal of Probability and Stochastic Processes. ISSN 1744-2508

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Identification Number: 10.1080/17442508.2021.1935952

Abstract

We study a two-dimensional discounted optimal stopping problem related to the pricing of perpetual commodity equities in a model of financial markets in which the behaviour of the underlying asset price follows a generalized geometric Brownian motion and the dynamics of the convenience yield are described by an unobservable continuous-time Markov chain with two states. It is shown that the optimal time of exercise is the first time at which the commodity spot price paid in return to the fixed coupon rate hits a lower stochastic boundary being a monotone function of the running value of the filtering estimate of the state of the chain. We rigorously prove that the optimal stopping boundary is regular for the stopping region relative to the resulting two-dimensional diffusion process and the value function is continuously differentiable with respect to the both variables. It is verified by means of a change-of-variable formula with local time on surfaces that the value function and the boundary are determined as a unique solution of the associated parabolic-type free-boundary problem. We also give a closed-form solution to the optimal stopping problem for the case of an observable Markov chain.

Item Type: Article
Official URL: https://www.tandfonline.com/toc/gssr20/current
Additional Information: © 2021 The Author
Divisions: Mathematics
Subjects: Q Science > QA Mathematics
H Social Sciences > HA Statistics
Date Deposited: 18 May 2021 09:39
Last Modified: 02 Aug 2021 08:00
URI: http://eprints.lse.ac.uk/id/eprint/110493

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