Robust Time-Inconsistent Stochastic Control Problems

Automatica, Forthcoming

20 Pages Posted: 13 Sep 2017 Last revised: 23 Mar 2018

See all articles by Chi Seng Pun

Chi Seng Pun

Nanyang Technological University (NTU) - School of Physical and Mathematical Sciences

Date Written: September 11, 2017

Abstract

This paper establishes a general analytical framework for continuous-time stochastic control problems for an ambiguity-averse agent (AAA) with time-inconsistent preference, where the control problems do not satisfy Bellman's principle of optimality. The AAA is concerned about model uncertainty in the sense that she is not completely confident in the reference model of the controlled Markov state process and rather considers some similar alternative models. The problems of interest are studied within a set of dominated models and the AAA seeks for an optimal decision that is robust with respect to model risks. We adopt a game-theoretic framework and the concept of subgame perfect Nash equilibrium to derive an extended dynamic programming equation and extended Hamilton -- Jacobi -- Bellman -- Isaacs equations for characterizing the robust dynamically optimal control of the problem. We also prove a verification theorem to theoretically support our construction of robust control. To illustrate the tractability of the proposed framework, we study an example of robust dynamic mean-variance portfolio selection under two cases: 1. constant risk aversion; and 2. state-dependent risk aversion.

Keywords: Robust Time-Consistent Stochastic Control, Time-Inconsistent Preference, Extended Dynamic Programming Approach, Hamilton--Jacobi--Bellman--Isaacs Equations, Robust Dynamic Mean-Variance Portfolio, State-Dependent Risk and Ambiguity Aversion, Abel's Differential Equations

JEL Classification: C61, C68, C72, D81, D92, G11

Suggested Citation

Pun, Chi Seng, Robust Time-Inconsistent Stochastic Control Problems (September 11, 2017). Automatica, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3035656 or http://dx.doi.org/10.2139/ssrn.3035656

Chi Seng Pun (Contact Author)

Nanyang Technological University (NTU) - School of Physical and Mathematical Sciences ( email )

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21 Nanyang Link
Singapore, 637371
Singapore
(+65) 6513 7468 (Phone)

HOME PAGE: http://www.ntu.edu.sg/home/cspun/

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