Information relaxations and duality in stochastic dynamic programs

We describe a general technique for determining upper bounds on maximal values (or lower bounds on minimal costs) in stochastic dynamic programs. In this approach, we relax the nonanticipativity constraints that require decisions to depend only on the information available at the time a decision is made and impose a "penalty" that punishes violations of nonanticipativity. In applications, the hope is that this relaxed version of the problem will be simpler to solve than the original dynamic program. The upper bounds provided by this dual approach complement lower bounds on values that may be found by simulating with heuristic policies. We describe the theory underlying this dual approach and establish weak duality, strong duality, and complementary slackness results that are analogous to the duality results of linear programming. We also study properties of good penalties. Finally, we demonstrate the use of this dual approach in an adaptive inventory control problem with an unknown and changing demand distribution and in valuing options with stochastic volatilities and interest rates. These are complex problems of significant practical interest that are quite difficult to solve to optimality. In these examples, our dual approach requires relatively little additional computation and leads to tight bounds on the optimal values. © 2010 INFORMS.

Optimal Capital Requirements in Financial Networks with Fire Sales

I explore and analyze a problem of finding the socially optimal capital requirements for financial institutions considering two distinct channels of contagion: direct exposures among the institutions, as represented by a network and fire sales externalities, which reflect the negative price impact of massive liquidation of assets.These two channels amplify shocks from individual financial institutions to the financial system as a whole and thus increase the risk of joint defaults amongst the interconnected financial institutions; this is often referred to as systemic risk. In the model, there is a trade-off between reducing systemic risk and raising the capital requirements of the financial institutions. The policymaker considers this trade-off and determines the optimal capital requirements for individual financial institutions. I provide a method for finding and analyzing the optimal capital requirements that can be applied to arbitrary network structures and arbitrary distributions of investment returns.

In particular, I first consider a network model consisting only of direct exposures and show that the optimal capital requirements can be found by solving a stochastic linear programming problem. I then extend the analysis to financial networks with default costs and show the optimal capital requirements can be found by solving a stochastic mixed integer programming problem. The computational complexity of this problem poses a challenge, and I develop an iterative algorithm that can be efficiently executed. I show that the iterative algorithm leads to solutions that are nearly optimal by comparing it with lower bounds based on a dual approach. I also show that the iterative algorithm converges to the optimal solution.

Finally, I incorporate fire sales externalities into the model. In particular, I am able to extend the analysis of systemic risk and the optimal capital requirements with a single illiquid asset to a model with multiple illiquid assets. The model with multiple illiquid assets incorporates liquidation rules used by the banks. I provide an optimization formulation whose solution provides the equilibrium payments for a given liquidation rule.

I further show that the socially optimal capital problem using the ``socially optimal liquidation" and prioritized liquidation rules can be formulated as a convex and convex mixed integer problem, respectively. Finally, I illustrate the results of the methodology on numerical examples and

discuss some implications for capital regulation policy and stress testing.

Confidence intervals for half-life deviations from purchasing power parity

Existing point estimates of half-life deviations from purchasing power parity (PPP), around 3-5 years, suggest that the speed of convergence is extremely slow. This article assesses the degree of uncertainty around these point estimates by using local-to-unity asymptotic theory to construct confidence intervals that are robust to high persistence in small samples. The empirical evidence suggests that the lower bound of the confidence interval is between four and eight quarters for most currencies, which is not inconsistent with traditional price-stickiness explanations. However, the upper bounds are infinity for all currencies, so we cannot provide conclusive evidence in favor of PPP either. © 2005 American Statistical Association.

A theory of hypoellipticity and unique ergodicity for semilinear stochastic PDEs

We present a theory of hypoellipticity and unique ergodicity for semilinear parabolic stochastic PDEs with "polynomial" nonlinearities and additive noise, considered as abstract evolution equations in some Hilbert space. It is shown that if Hörmander's bracket condition holds at every point of this Hilbert space, then a lower bound on the Malliavin covariance operatorμt can be obtained. Informally, this bound can be read as "Fix any finite-dimensional projection on a subspace of sufficiently regular functions. Then the eigenfunctions of μt with small eigenvalues have only a very small component in the image of Π." We also show how to use a priori bounds on the solutions to the equation to obtain good control on the dependency of the bounds on the Malliavin matrix on the initial condition. These bounds are sufficient in many cases to obtain the asymptotic strong Feller property introduced in [HM06]. One of the main novel technical tools is an almost sure bound from below on the size of "Wiener polynomials," where the coefficients are possibly non-adapted stochastic processes satisfying a Lips chitz condition. By exploiting the polynomial structure of the equations, this result can be used to replace Norris' lemma, which is unavailable in the present context. We conclude by showing that the two-dimensional stochastic Navier-Stokes equations and a large class of reaction-diffusion equations fit the framework of our theory.

Unipedal balance is affected by lower extremity joint arthroplasty procedure 1 year following surgery.

Lower Extremity Joint Arthroplasty (LEJA) surgery is an effective way to alleviate painful osteoarthritis. Unfortunately, these surgeries do not normalize the loading asymmetry during the single leg stance phase of gait. Therefore, we examined single leg balance in 234 TJA patients (75 hips, 65 knees, 94 ankles) approximately 12 months following surgery. Patients passed if they maintained single leg balance for 10s with their eyes open. Patients one year following total hip arthroplasty (THA-63%) and total knee arthroplasty (TKA-69%) had similar pass rates compared to a total ankle arthroplasty (TAA-9%). Patients following THA and TKA exhibit better unilateral balance in comparison with TAA patients. It may be beneficial to include a rigorous proprioception and balance training program in TAA patients to optimize functional outcomes.

Dietary inference from upper and lower molar morphology in platyrrhine primates.

The correlation between diet and dental topography is of importance to paleontologists seeking to diagnose ecological adaptations in extinct taxa. Although the subject is well represented in the literature, few studies directly compare methods or evaluate dietary signals conveyed by both upper and lower molars. Here, we address this gap in our knowledge by comparing the efficacy of three measures of functional morphology for classifying an ecologically diverse sample of thirteen medium- to large-bodied platyrrhines by diet category (e.g., folivore, frugivore, hard object feeder). We used Shearing Quotient (SQ), an index derived from linear measurements of molar cutting edges and two indices of crown surface topography, Occlusal Relief (OR) and Relief Index (RFI). Using SQ, OR, and RFI, individuals were then classified by dietary category using Discriminate Function Analysis. Both upper and lower molar variables produce high classification rates in assigning individuals to diet categories, but lower molars are consistently more successful. SQs yield the highest classification rates. RFI and OR generally perform above chance. Upper molar RFI has a success rate below the level of chance. Adding molar length enhances the discriminatory power for all variables. We conclude that upper molar SQs are useful for dietary reconstruction, especially when combined with body size information. Additionally, we find that among our sample of platyrrhines, SQ remains the strongest predictor of diet, while RFI is less useful at signaling dietary differences in absence of body size information. The study demonstrates new ways for inferring the diets of extinct platyrrhine primates when both upper and lower molars are available, or, for taxa known only from upper molars. The techniques are useful in reconstructing diet in stem representatives of anthropoid clade, who share key aspects of molar morphology with extant platyrrhines.