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An efficient algorithm based on eigenfunction expansions for some optimal timing problems in finance. (English) Zbl 1334.60065
Summary: This paper considers the optimal switching problem and the optimal multiple stopping problem for one-dimensional Markov processes in a finite horizon discrete time framework. We develop a dynamic programming procedure to solve these problems and provide easy-to-verify conditions to characterize connectedness of switching and exercise regions. When the transition or Feynman-Kac semigroup of the Markov process has discrete spectrum, we develop an efficient algorithm based on eigenfunction expansions that explicitly solves the dynamic programming problem. We also prove that the algorithm converges exponentially in the series truncation level. Our method is applicable to a rich family of Markov processes which are widely used in financial applications, including many diffusions as well as jump-diffusions and pure jump processes that are constructed from diffusion through time change. In particular, many of these processes are often used to model mean-reversion. We illustrate the versatility of our method by considering three applications: valuation of combination shipping carriers, interest-rate chooser flexible caps and commodity swing options. Numerical examples show that our method is highly efficient and has significant computational advantages over standard numerical PDE methods that are typically used to solve such problems.

60G40 Stopping times; optimal stopping problems; gambling theory
60J60 Diffusion processes
60J75 Jump processes (MSC2010)
91G80 Financial applications of other theories
49L20 Dynamic programming in optimal control and differential games
90C39 Dynamic programming
65K05 Numerical mathematical programming methods
Full Text: DOI
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