Journal of Applied Mathematics and Stochastic Analysis
Volume 2006 (2006), Article ID 95203, 27 pages
doi:10.1155/JAMSA/2006/95203
Abstract
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.