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dc.contributor.authorStein, Jerome L.en_US
dc.date.accessioned2009-03-02en_US
dc.date.accessioned2009-07-28T08:48:36Z-
dc.date.available2009-07-28T08:48:36Z-
dc.date.issued2009en_US
dc.identifier.urihttp://hdl.handle.net/10419/26584-
dc.description.abstractThis interdisciplinary paper explains how mathematical techniques of stochastic optimal control can be applied to the recent subprime mortgage crisis. Why did the financial markets fail to anticipate the recent debt crisis, despite the large literature in mathematical finance concerning optimal portfolio allocation and stopping rules? The uncertainty concerns the capital gain, the return on capital and the interest rate. An optimal debt ratio is derived where the drift is probabilistic but subject to economic constraints. The crises occurred because the market neglected to consider pertinent economic constraints in the dynamic stochastic optimization. The first constraint is that the firm should not be viewed in isolation. The optimizer should be the entire industry. The second economic constraint concerns the modeling of the drift of the price of the asset. The vulnerability of the borrowing firm to shocks from the capital gain, the return to capital or the interest rate, does not depend upon the actual debt/net worth per se. Instead it increases in proportion to the difference between the Actual and Optimal debt ratio, called the excess debt. A general measure of excess debt is derived and I show that it is an early warning signal of the recent crisis.en_US
dc.language.isoengen_US
dc.publisherCESifo Münchenen_US
dc.relation.ispartofseriesCESifo working paper 2539en_US
dc.subject.jelC61en_US
dc.subject.jelD81en_US
dc.subject.jelD91en_US
dc.subject.jelD92en_US
dc.subject.jelG1en_US
dc.subject.jelG11en_US
dc.subject.jelG12en_US
dc.subject.jelG14en_US
dc.subject.ddc330en_US
dc.subject.keywordStochastic optimal controlen_US
dc.subject.keyworddynamic optimizationen_US
dc.subject.keywordmortgage crisisen_US
dc.subject.keywordIto equationen_US
dc.subject.keywordrisk aversionen_US
dc.subject.keyworddebt managementen_US
dc.subject.keywordwarning signalsen_US
dc.subject.stwSchuldenen_US
dc.subject.stwKreditrisikoen_US
dc.subject.stwPortfolio-Managementen_US
dc.subject.stwKontrolltheorieen_US
dc.subject.stwFrühwarnsystemen_US
dc.subject.stwHypotheken_US
dc.subject.stwFinanzmarktkriseen_US
dc.subject.stwTheorieen_US
dc.titleApplication of stochastic optimal control to financial market debt crisesen_US
dc.typeWorking Paperen_US
dc.identifier.ppn592833496en_US
dc.rightshttp://www.econstor.eu/dspace/Nutzungsbedingungen-
Appears in Collections:CESifo Working Papers, CESifo Group Munich

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