2012, 2(3): 271-329. doi: 10.3934/mcrf.2012.2.271

Time-inconsistent optimal control problems and the equilibrium HJB equation

1. 

Department of Mathematics, University of Central Florida, Orlando, FL 32816

Received  April 2012 Revised  May 2012 Published  August 2012

A general time-inconsistent optimal control problem is considered for stochastic differential equations with deterministic coefficients. Under suitable conditions, a Hamilton-Jacobi-Bellman type equation is derived for the equilibrium value function of the problem. Well-posedness such an equation is studied, and time-consistent equilibrium strategies are constructed. As special cases, the linear-quadratic problem and a generalized Merton's portfolio problem are investigated.
Citation: Jiongmin Yong. Time-inconsistent optimal control problems and the equilibrium HJB equation. Mathematical Control & Related Fields, 2012, 2 (3) : 271-329. doi: 10.3934/mcrf.2012.2.271
References:
[1]

S. Basak and G. Chabakauri, Dynamic mean-variance asset allocation,, Rev. Finan. Stud., 23 (2010), 2970. doi: 10.1093/rfs/hhq028.

[2]

T. Björk and A. Murgoci, A general theory of Markovian time inconsistent stochasitic control problem,, working paper., ().

[3]

T. Björk, A. Murgoci and X. Y. Zhou, Mean varaiance portfolio optimization with state dependent risk aversion,, Math. Finance, ().

[4]

E. V. Böhm-Bawerk, "The Positive Theory of Capital,'', Books for Libraries Press, (1891).

[5]

A. Caplin and J. Leahy, The recursive approach to time inconsistency,, J. Econ. Theory, 131 (2006), 134. doi: 10.1016/j.jet.2005.05.006.

[6]

I. Ekeland and A. Lazrak, The golden rule when preferences are time inconsistent,, Math. Finan. Econ., 4 (2010), 29.

[7]

I. Ekeland and T. A. Pirvu, Investment and consumption without commitment,, Math. Finan. Econ., 2 (2008), 57.

[8]

I. Ekeland, O. Mbodji and T. A. Pirvu, Time-consistent portfolio management,, SIAM J. Financial Math., 3 (2012), 1.

[9]

W. H. Fleming and H. M. Soner, "Controlled Markov Processes and Viscosity Solutions,'', 2nd edition, 25 (2006).

[10]

A. Friedman, "Partial Differential Equations of Parabolic Type,'', Prentice Hall, (1964).

[11]

S. M. Goldman, Consistent plans,, Review of Economic Studies, 47 (1980), 533.

[12]

S. R. Grenadier and N. Wang, Investment under uncertainty and time-inconsistent preferences,, J. Finan. Econ., 84 (2007), 2.

[13]

P. J.-J. Herings and K. I. M. Rohde, Time-inconsistent preferences in a general equilibrium model,, Econ. Theory, 29 (2006), 591. doi: 10.1007/s00199-005-0020-3.

[14]

Y. Hu, H. Jin and X. Y. Zhou, Time-inconsistent stochastic linear-quadratic control,, , (2011).

[15]

D. Hume, "A Treatise of Human Nature,'', First edition, (1739).

[16]

W. S. Jevons, "Theory of Political Economy,'', McMillan, (1871).

[17]

L. Karp and I. H. Lee, Time-consistent policies,, J. Econ. Theory, 112 (2003), 353. doi: 10.1016/S0022-0531(03)00067-X.

[18]

D. Laibson, Golden eggs and hyperbolic discounting,, Quarterly J. Econ., 112 (1997), 443. doi: 10.1162/003355397555253.

[19]

J. Ma, P. Protter and J. Yong, Solving forward-backward stochastic differential equations explicitly-a four-step scheme,, Probab. Theory Related Fields, 98 (1994), 339. doi: 10.1007/BF01192258.

[20]

J. Ma and J. Yong, "Forward-Backward Stochastic Differential Equations and Their Applications,'', Lecture Notes in Math., 1702 (1999).

[21]

A. Malthus, An essay on the principle of population,, in, (1986), 2.

[22]

A. Marshall, "Principles of Economics,'', 1st ed., (1890).

[23]

J. Marin-Solano and J. Navas, Consumption and portfolio rules for time-inconsistent investors,, European J. Operational Research, 201 (2010), 860. doi: 10.1016/j.ejor.2009.04.005.

[24]

J. Marin-Solano and E. V. Shevkoplyas, Non-constant discounting and differential games with random time horizon,, Automatica J. IFAC, 47 (2011), 2626. doi: 10.1016/j.automatica.2011.09.010.

[25]

M. Miller and M. Salmon, Dynamic games and the time inconsistency of optimal policy in open economics,, The Economic Journal, 95 (1985), 124. doi: 10.2307/2232876.

[26]

I. Palacios-Huerta, Time-inconsistent preferences in Adam Smith and Davis Hume,, History of Political Economy, 35 (2003), 241. doi: 10.1215/00182702-35-2-241.

[27]

V. Pareto, "Manuel d'Économie Politique,'', Girard and Brieve, (1909).

[28]

B. Peleg and M. E. Yaari, On the existence of a consistent course of action when tastes are changing,, Review of Economic Studies, 40 (1973), 391.

[29]

R. A. Pollak, Consistent planning,, Review of Economic Studies, 35 (1968), 185. doi: 10.2307/2296547.

[30]

A. Smith, "The Theory of Moral Sentiments,'', First edition, (1759).

[31]

R. H. Strotz, Myopia and inconsistency indynamic utility maximization,, Review of Econ. Studies, 23 (1955), 165. doi: 10.2307/2295722.

[32]

L. Tesfatsion, Time inconsistency of benevolent government economics,, J. Public Economics, 31 (1986), 25. doi: 10.1016/0047-2727(86)90070-8.

[33]

J. Yong, Backward stochastic Volterra integral equations and some related problems,, Stoch. Proc. Appl., 116 (2006), 779. doi: 10.1016/j.spa.2006.01.005.

[34]

J. Yong, Well-posedness and regularity of backward stochastic Volterra integral equations,, Prob. Theory Rel. Fields, 142 (2008), 21. doi: 10.1007/s00440-007-0098-6.

[35]

J. Yong, A deterministic linear quadratic time-inconsistent optimal control problem,, Math. Control Related Fields, 1 (2011), 83.

[36]

J. Yong, Deterministic time-inconsistent optimal control problems-An essentially cooperative approach,, Acta Math. Appl. Sinica Engl. Ser., 28 (2012), 1.

[37]

J. Yong and X. Y. Zhou, "Stochastic Controls. Hamiltonian Systems and HJB Equations,'', Applications of Mathematics (New York), 43 (1999).

show all references

References:
[1]

S. Basak and G. Chabakauri, Dynamic mean-variance asset allocation,, Rev. Finan. Stud., 23 (2010), 2970. doi: 10.1093/rfs/hhq028.

[2]

T. Björk and A. Murgoci, A general theory of Markovian time inconsistent stochasitic control problem,, working paper., ().

[3]

T. Björk, A. Murgoci and X. Y. Zhou, Mean varaiance portfolio optimization with state dependent risk aversion,, Math. Finance, ().

[4]

E. V. Böhm-Bawerk, "The Positive Theory of Capital,'', Books for Libraries Press, (1891).

[5]

A. Caplin and J. Leahy, The recursive approach to time inconsistency,, J. Econ. Theory, 131 (2006), 134. doi: 10.1016/j.jet.2005.05.006.

[6]

I. Ekeland and A. Lazrak, The golden rule when preferences are time inconsistent,, Math. Finan. Econ., 4 (2010), 29.

[7]

I. Ekeland and T. A. Pirvu, Investment and consumption without commitment,, Math. Finan. Econ., 2 (2008), 57.

[8]

I. Ekeland, O. Mbodji and T. A. Pirvu, Time-consistent portfolio management,, SIAM J. Financial Math., 3 (2012), 1.

[9]

W. H. Fleming and H. M. Soner, "Controlled Markov Processes and Viscosity Solutions,'', 2nd edition, 25 (2006).

[10]

A. Friedman, "Partial Differential Equations of Parabolic Type,'', Prentice Hall, (1964).

[11]

S. M. Goldman, Consistent plans,, Review of Economic Studies, 47 (1980), 533.

[12]

S. R. Grenadier and N. Wang, Investment under uncertainty and time-inconsistent preferences,, J. Finan. Econ., 84 (2007), 2.

[13]

P. J.-J. Herings and K. I. M. Rohde, Time-inconsistent preferences in a general equilibrium model,, Econ. Theory, 29 (2006), 591. doi: 10.1007/s00199-005-0020-3.

[14]

Y. Hu, H. Jin and X. Y. Zhou, Time-inconsistent stochastic linear-quadratic control,, , (2011).

[15]

D. Hume, "A Treatise of Human Nature,'', First edition, (1739).

[16]

W. S. Jevons, "Theory of Political Economy,'', McMillan, (1871).

[17]

L. Karp and I. H. Lee, Time-consistent policies,, J. Econ. Theory, 112 (2003), 353. doi: 10.1016/S0022-0531(03)00067-X.

[18]

D. Laibson, Golden eggs and hyperbolic discounting,, Quarterly J. Econ., 112 (1997), 443. doi: 10.1162/003355397555253.

[19]

J. Ma, P. Protter and J. Yong, Solving forward-backward stochastic differential equations explicitly-a four-step scheme,, Probab. Theory Related Fields, 98 (1994), 339. doi: 10.1007/BF01192258.

[20]

J. Ma and J. Yong, "Forward-Backward Stochastic Differential Equations and Their Applications,'', Lecture Notes in Math., 1702 (1999).

[21]

A. Malthus, An essay on the principle of population,, in, (1986), 2.

[22]

A. Marshall, "Principles of Economics,'', 1st ed., (1890).

[23]

J. Marin-Solano and J. Navas, Consumption and portfolio rules for time-inconsistent investors,, European J. Operational Research, 201 (2010), 860. doi: 10.1016/j.ejor.2009.04.005.

[24]

J. Marin-Solano and E. V. Shevkoplyas, Non-constant discounting and differential games with random time horizon,, Automatica J. IFAC, 47 (2011), 2626. doi: 10.1016/j.automatica.2011.09.010.

[25]

M. Miller and M. Salmon, Dynamic games and the time inconsistency of optimal policy in open economics,, The Economic Journal, 95 (1985), 124. doi: 10.2307/2232876.

[26]

I. Palacios-Huerta, Time-inconsistent preferences in Adam Smith and Davis Hume,, History of Political Economy, 35 (2003), 241. doi: 10.1215/00182702-35-2-241.

[27]

V. Pareto, "Manuel d'Économie Politique,'', Girard and Brieve, (1909).

[28]

B. Peleg and M. E. Yaari, On the existence of a consistent course of action when tastes are changing,, Review of Economic Studies, 40 (1973), 391.

[29]

R. A. Pollak, Consistent planning,, Review of Economic Studies, 35 (1968), 185. doi: 10.2307/2296547.

[30]

A. Smith, "The Theory of Moral Sentiments,'', First edition, (1759).

[31]

R. H. Strotz, Myopia and inconsistency indynamic utility maximization,, Review of Econ. Studies, 23 (1955), 165. doi: 10.2307/2295722.

[32]

L. Tesfatsion, Time inconsistency of benevolent government economics,, J. Public Economics, 31 (1986), 25. doi: 10.1016/0047-2727(86)90070-8.

[33]

J. Yong, Backward stochastic Volterra integral equations and some related problems,, Stoch. Proc. Appl., 116 (2006), 779. doi: 10.1016/j.spa.2006.01.005.

[34]

J. Yong, Well-posedness and regularity of backward stochastic Volterra integral equations,, Prob. Theory Rel. Fields, 142 (2008), 21. doi: 10.1007/s00440-007-0098-6.

[35]

J. Yong, A deterministic linear quadratic time-inconsistent optimal control problem,, Math. Control Related Fields, 1 (2011), 83.

[36]

J. Yong, Deterministic time-inconsistent optimal control problems-An essentially cooperative approach,, Acta Math. Appl. Sinica Engl. Ser., 28 (2012), 1.

[37]

J. Yong and X. Y. Zhou, "Stochastic Controls. Hamiltonian Systems and HJB Equations,'', Applications of Mathematics (New York), 43 (1999).

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