SIAM Journal on Control and Optimization, Vol.47, No.4, 1785-1813, 2008
Optimal reflection of diffusions and barrier options pricing under constraints
We introduce a new class of control problems in which the gain depends on the solution of a stochastic differential equation (SDE) reflected at the boundary of a bounded domain, along directions which are controlled by a bounded variation process. We provide a PDE characterization of the associated value function. This study is motivated by applications in mathematical finance, where such equations are related to the pricing of barrier options under portfolio constraints.
Keywords:reflected diffusion;Skorokhod problem;viscosity solutions;barrier option;portfolio constraints