Finite-horizon optimal investment with transaction costs: A parabolic double obstacle problem

Abstract

This paper concerns optimal investment problem of a CRRA investor who faces proportional transaction costs and finite time horizon. From the angle of stochastic control, it is a singular control problem, whose value function is governed by a time-dependent HJB equation with gradient constraints. We reveal that the problem is equivalent to a parabolic double obstacle problem involving two free boundaries that correspond to the optimal buying and selling policies. This enables us to make use of the well-developed theory of obstacle problem to attack the problem. The C2, 1 regularity of the value function is proven and the behaviors of the free boundaries are completely characterized. © 2008 Elsevier Inc. All rights reserved.