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Optimal redeeming strategy of stock loans under drift uncertainty

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  • Zuo Quan Xu
  • Fahuai Yi

Abstract

In practice, one must recognize the inevitable incompleteness of information while making decisions. In this paper, we consider the optimal redeeming problem of stock loans under a state of incomplete information presented by the uncertainty in the (bull or bear) trends of the underlying stock. This is called drift uncertainty. Due to the unavoidable need for the estimation of trends while making decisions, the related Hamilton-Jacobi-Bellman (HJB) equation is of a degenerate parabolic type. Hence, it is very hard to obtain its regularity using the standard approach, making the problem different from the existing optimal redeeming problems without drift uncertainty. We present a thorough and delicate probabilistic and functional analysis to obtain the regularity of the value function and the optimal redeeming strategies. The optimal redeeming strategies of stock loans appear significantly different in the bull and bear trends.

Suggested Citation

  • Zuo Quan Xu & Fahuai Yi, 2019. "Optimal redeeming strategy of stock loans under drift uncertainty," Papers 1901.06680, arXiv.org.
    • Handle: RePEc:arx:papers:1901.06680
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    References listed on IDEAS

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    1. Kristoffer Glover & Hardy Hulley, 2022. "Short Selling With Margin Risk And Recall Risk," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 25(02), pages 1-33, March.

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