A Coupled System of Integrodifferential Equations Arising in Liquidity Risk Model

We study the mathematical aspects of the portfolio/consumption choice problem in a market model with liquidity risk introduced in (Pham and Tankov, Math. Finance, 2006, to appear). In this model, the investor can trade and observe stock prices only at exogenous Poisson arrival times. He may also consume continuously from his cash holdings, and his goal is to maximize his expected utility from consumption. This is a mixed discrete/continuous time stochastic control problem, nonstandard in the literature. We show how the dynamic programming principle leads to a coupled system of Integro-Differential Equations (IDE), and we prove an analytic characterization of this control problem by adapting the concept of viscosity solutions. This coupled system of IDE may be numerically solved by a decoupling algorithm, and this is the topic of a companion paper (Pham and Tankov, Math. Finance, 2006, to appear).