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dc.contributor.authorStein, Jerome L.en
dc.date.accessioned2009-03-02-
dc.date.accessioned2009-07-28T08:48:36Z-
dc.date.available2009-07-28T08:48:36Z-
dc.date.issued2009-
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
dc.language.isoengen
dc.publisher|aCenter for Economic Studies and ifo Institute (CESifo) |cMunichen
dc.relation.ispartofseries|aCESifo Working Paper |x2539en
dc.subject.jelC61en
dc.subject.jelD81en
dc.subject.jelD91en
dc.subject.jelD92en
dc.subject.jelG1en
dc.subject.jelG11en
dc.subject.jelG12en
dc.subject.jelG14en
dc.subject.ddc330en
dc.subject.keywordStochastic optimal controlen
dc.subject.keyworddynamic optimizationen
dc.subject.keywordmortgage crisisen
dc.subject.keywordIto equationen
dc.subject.keywordrisk aversionen
dc.subject.keyworddebt managementen
dc.subject.keywordwarning signalsen
dc.subject.stwSchuldenen
dc.subject.stwKreditrisikoen
dc.subject.stwPortfolio-Managementen
dc.subject.stwKontrolltheorieen
dc.subject.stwFrühwarnsystemen
dc.subject.stwHypotheken
dc.subject.stwFinanzmarktkriseen
dc.subject.stwTheorieen
dc.titleApplication of stochastic optimal control to financial market debt crises-
dc.typeWorking Paperen
dc.identifier.ppn592833496en
dc.rightshttp://www.econstor.eu/dspace/Nutzungsbedingungenen

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