Let's suppose we owe an asset and its path is given by the following SDE: $$ S(t) = A(S, t) dt + B(S, t) d\widetilde{W}$$ where $\widetilde{W}$ is a Brownian motion (under risk neutral measure). What is the optimal strategy of selling this asset? What is the value of a portfolio consisting of this single asset?

My understanding is that there is a certain threshold the asset reaches that should trigger the sell. If the value of the portfolio is $V(S(t), t)$ then $$V(x, t) = \widetilde{\mathbb{E}}[e^{-\int_t^{\tau}R(s)ds}S(\tau)]$$ ($x = S(t)$, and $\tau$ is a stopping time for the threshold.)

My question: what is the PDE governing $V(x, t)$? How do I get (derive) it? What is the general logic of getting PDEs for american style derivatives? I understand the presentation Shreve gives about linear complementarity conditions in his book "Stochastic calculus for finance, vol II".

Another question (somewhat of a digression): if the SDE is in real world measure, how do we get PDEs? Only by transforming the measure through Girsanov's theorem?

  • $\begingroup$ Your definition of the porfolio value is a bit strange, you are just discounting the asset at the stopping time. $\endgroup$
    – Canardini
    Dec 23, 2019 at 20:13
  • $\begingroup$ @Canardini Why is it strange? Isn't it a standard risk neutral valuation? $\endgroup$
    – Al Guy
    Dec 24, 2019 at 16:59
  • $\begingroup$ What is $V$ then ? What are you trying to value ? I read your formula as the value of receiving the stock at time $\tau$ $\endgroup$
    – Canardini
    Dec 24, 2019 at 17:01
  • $\begingroup$ @Canardini I agree that with a stock it doesn't make a lot of sense as the discounting should produce the current stock price because of no arbitrage condition. But we can consider S as some general portfolio. Is it reasonable? $\endgroup$
    – Al Guy
    Dec 30, 2019 at 2:56
  • $\begingroup$ The portfolio will have the same property, you are discounting a tradable asset, therefore is a martingale. $\endgroup$
    – Canardini
    Dec 30, 2019 at 15:12


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