Stochastic differential portfolio games

Abstract

We study stochastic dynamic investment games in continuous time between two investors (players) who have available two different, but possibly correlated, investment opportunities. There is a single payoff function which depends on both investors’ wealth processes. One player chooses a dynamic portfolio strategy in order to maximize this expected payoff, while his opponent is simultaneously choosing a dynamic portfolio strategy so as to minimize the same quantity. This leads to a stochastic differential game with controlled drift and variance. For the most part, we consider games with payoffs that depend on the achievement of relative performance goals and/or shortfalls. We provide conditions under which a game with a general payoff function has an achievable value, and give an explicit representation for the value and resulting equilibrium portfolio strategies in that case. It is shown that non-perfect correlation is required to rule out trivial solutions. We then use this general result explicitly to solve a variety of specific games. For example, we solve a probability maximizing game, where each investor is trying to maximize the probability of beating the other's return by a given predetermined percentage. We also consider objectives related to the minimization or maximization of the expected time until one investor's return beats the other investor's return by a given percentage. Our results allow a new interpretation of the market price of risk in a Black-Scholes world. Games with discounting are also discussed, as are games of fixed duration related to utility maximization.