Forward–Backward Stochastic Differential Games and Stochastic Control under Model Uncertainty

• Published in: Journal of optimization theory and applications 2014-04, Vol.161 (1), p.22-55
• Main Authors: Øksendal, Bernt, Sulem, Agnès
• Format: Article
• Language: English
• Subjects: Applications of Mathematics; Calculus of Variations and Optimal Control; Optimization; Differential equations; Differential games; Engineering; Equilibrium; Equivalence; Games; Mathematics; Mathematics and Statistics; Operations Research/Decision Theory; Optimization; Principles; Risk; Robust control; Stochastic models; Stochasticity; Studies; Theory; Theory of Computation; Uncertainty; Utility functions
• ISSN: 0022-3239; 1573-2878
• DOI: 10.1007/s10957-012-0166-7

We study optimal stochastic control problems with jumps under model uncertainty. We rewrite such problems as stochastic differential games of forward–backward stochastic differential equations. We prove general stochastic maximum principles for such games, both in the zero-sum case (finding conditions for saddle points) and for the nonzero sum games (finding conditions for Nash equilibria). We then apply these results to study robust optimal portfolio-consumption problems with penalty. We establish a connection between market viability under model uncertainty and equivalent martingale measures. In the case with entropic penalty, we prove a general reduction theorem, stating that a optimal portfolio-consumption problem under model uncertainty can be reduced to a classical portfolio-consumption problem under model certainty , with a change in the utility function, and we relate this to risk sensitive control. In particular, this result shows that model uncertainty increases the Arrow–Pratt risk aversion index.