Article ID: | iaor20084531 |
Country: | United States |
Volume: | 2006 |
Issue: | 95203 |
Start Page Number: | 1 |
End Page Number: | 27 |
Publication Date: | Jan 2006 |
Journal: | Journal of Applied Mathematics and Stochastic Analysis |
Authors: | Cvitani Jaka, Wan Xuhu, Zhang Jianfeng |
Keywords: | stochastic processes, financial |
We present a unified approach to solving contracting problems with full information in models driven by Brownian motion. We apply the stochastic maximum principle to give necessary and sufficient conditions for contracts that implement the so-called first-best solution. The optimal contract is proportional to the difference between the underlying process controlled by the agent and a stochastic, state-contingent benchmark. Our methodology covers a number of frameworks considered in the existing literature. The main finance applications of this theory are optimal compensation of company executives and of portfolio managers.