Time Inconsistent Stochastic Control in Continuous Time: Theory and Examples

Abstract: In this paper, which is a continuation of the previously published discrete time paper we develop a theory for continuous time stochastic control problems which, in various ways, are time inconsistent in the sense that they do not admit a Bellman optimality principle. We study these problems within a game theoretic framework, and we look for Nash subgame perfect equilibrium points. For a general controlled continuous time Markov process and a fairly general objective functional we derive an extension of the standard Hamilton-Jacobi-Bellman equation, in the form of a system of non-linear equations, for the determination for the equilibrium strategy as well as the equilibrium value function. As applications of the general theory we study non exponential discounting, various types of mean variance problems, a point process example, as well as a time inconsistent linear quadratic regulator. We also present a study of time inconsistency within the framework of a general equilibrium production economy of Cox-Ingersoll-Ross type.