Taking the Challenge in Coping with Time Inconsistency in Dynamic Decision Making


Department of Systems Engineering and Engineering Management
The Chinese University of Hong Kong

Inaugural Lecture of Patrick Huen Wing Ming Professorship of Systems Engineering and Engineering Management
Title: Taking the Challenge in Coping with Time Inconsistency in Dynamic Decision Making
Speaker: Professor Duan Li,
Patrick Huen Wing Ming Professor of Systems Engineering and Engineering Management
Date: April 15, 2014 (Tuesday)
Time: 5:15 PM
Venue: T Y Wong Hall
       5/F, Ho Sin-Hang Engineering Building
       The Chinese University of Hong Kong.

Short Biography of the speaker:
Professor Duan Li was born in Shanghai, China. He graduated from the Department of Physics of Fudan University in Shanghai; received his ME degree in Automatic Control from Shanghai Jiaotong University; and received his PhD degree in Systems Engineering from Case Western Reserve University, Ohio USA. From 1987 to 1994, he was a faculty member at the University of Virginia, USA where he was anAssociate Professor (Research) in the Department of Systems Engineering and Associate Director of the Center for Risk Management ofEngineering Systems. He joined the Department of Systems Engineering and Engineering Management of The Chinese University of HongKong in December 1994 where he is currently Chair Professor of Systems Engineering and Engineering Management and where he served asthe department chairman from 2003 to 2012.
Professor Li's research interests include optimization, optimal control, financial engineering, and decision-making methodologies.He has authored and co-authored over 260 technical papers in these areas of which more than 170 are journal papers, includingnumerous publications in leading journals such as IEEE Transactions on Automatic Control, AUTOMATICA, SIAM Journal on Optimization,Mathematical Programming, Mathematics of Operations Research, Operations Research, Journal of Banking & Finance, and MathematicalFinance. He is also a co-author of the book entitled Nonlinear Integer Programming published by Springer in 2006. Professor Li hasmade numerous contributions in multi-objective optimization, nonconvex optimization, integer programming, optimal control andfinancial engineering. Most notably, he solved a long-standing challenge in extending Markowitz's classical mean-variance portfolioselection formulation to both a multi-period setting (together with Dr W L Ng) and continuous-time setting (together with ProfessorXunyu Zhou) and initialized a prominent research direction of dynamic mean-variance portfolio selection.
Professor Li is active in professional societies. He was or currently serves as an associate editor or a guest editor for severaljournals, including IEEE Transactions on Automatic Control, Journal of the Operations Research Society of China, Journal of GlobalOptimization and IIE Transactions on Operations Engineering. He has organized numerous international conferences as a co-chair. Heis currently Vice President of the Chinese National Society of Mathematical Programming, Vice President of the Chinese Society ofFinancial Systems Engineering, and a member of the Academic Committee of the Chinese National Research Center of Mathematics andCross-Disciplinary Science in Department of Finance and Economics. He currently also serves as Honorary Professor at Sun Yat-senBusiness School, Sun Yat-sen University.
We make decisions every day. If we were to order the many optimization methodologies dealing with sequential decision makingproblems on the basis of their overall fertility, dynamic programming pioneered by Richard Bellman would, without any doubt, be atthe top of the list. Applicability of dynamic programming, however, is based on the premise of the principle of optimality, whichstates that an optimal policy has the property that, whatever the initial state and initial decisions, the remaining decisions mustalso constitute an optimal policy with regard to the state resulting from previous decisions. The satisfaction of this assumption,in turn, requires that the preference (risk attitude) of a decision maker be unchanged over time, which is, unfortunately, oftenviolated by a time inconsistent mind setting of human behaviors.
Decision makers are thus often facing a dilemma in their daily life. The overall objective for the entire time horizon underconsideration often does not conform with a "local'' objective for a tail part of the time horizon, which yields a timeinconsistency between the global optimal decision (committed action) and local optimal decision (tempted action). In the language ofdynamic programming, the Bellman's principle of optimality fails in such situations, as the global and local interests derived fromtheir respective objectives are not consistent. When we extend the seminal mean-variance portfolio selection model by HarryMarkowitz to its dynamic counterpart, we immediately face such a dilemma.
While the current literature has been dominated by both "strategy of pre-commitment'' and "strategy of consistent planning'', theformer of which completely ignores the local incentives and the latter of which completely ignores the global objectives, we takethe challenge forward to identify a better strategy to balance long and short term interests when facing time inconsistency indynamic decision making. We construct a planner-doer mean-variance game formulation with self-control, where the planner (theinvestor who is in charge of the investment problem as a whole) can influence the preferences of doers (the investors who decide thecarried out strategy at different time instances) through commitment by punishment. Solving this game model, we derive an explicitdoer-perfect Nash equilibrium strategy adopted by the planner and the doers, and achieve a best trade-off between the global andlocal interests. We extend further the planner-doer game framework to generalized time inconsistent stochastic decision problems,and show that the framework is consistent with the current literature of self-control theory.
                      Everyone is invited to attend the talk.
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       Andy Chung,
       Department of Systems Engineering and Engineering Management,
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Tuesday, April 15, 2014 - 09:15 to 10:30