Optimal stopping involving a diffusion and its running maximum: a generalisation of the maximality principle

Abstract

The maximality principle has been a valuable tool in identifying the free-boundary functions that are associated with the solutions to several optimal stopping problems involving one-dimensional time-homogeneous diffusions and their running maximum processes. In its original form, the maximality principle identifies an optimal stopping boundary function as the maximal solution to a specific first-order nonlinear ODE that stays strictly below the diagonal in $\mathbb{R}^2$. In the context of a suitably tailored optimal stopping problem, we derive a substantial generalisation of the maximality principle: the optimal stopping boundary function is the maximal solution to a specific first-order nonlinear ODE that is associated with a solution to the optimal stopping problem's variational inequality.