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Classical Control with Linear Algebra


In an earlier lecture Linear Quadratic Dynamic Programming Problems we have studied how to solve a special class of dynamic optimization and prediction problems by applying the method of dynamic programming. In this class of problems

  • the objective function is quadratic in states and controls
  • the one-step transition function is linear
  • shocks are i.i.d. Gaussian or martingale differences

In this lecture and a companion lecture Classical Filtering with Linear Algebra, we study the classical theory of linear-quadratic (LQ) optimal control problems.

The classical approach does not use the two closely related methods – dynamic programming and Kalman filtering – that we describe in other lectures, namely, Linear Quadratic Dynamic Programming Problems and A First Look at the Kalman Filter

Instead they use either

  • \(z\)-transform and lag operator methods, or
  • matrix decompositions applied to linear systems of first-order conditions for optimum problems.

In this lecture and the sequel Classical Filtering with Linear Algebra, we mostly rely on elementary linear algebra

The main tool from linear algebra we’ll put to work here is LU decomposition

We’ll begin with discrete horizon problems

Then we’ll view infinite horizon problems as appropriate limits of these finite horizon problems

Later, we will examine the close connection between LQ control and least squares prediction and filtering problems

These classes of problems are connected in the sense that to solve each, essentially the same mathematics is used


Useful references include [Whi63], [HS80], [Orf88], [AP91], and [Mut60]

A Control Problem

Let \(L\) be the lag operator, so that, for sequence \(\{x_t\}\) we have \(L x_t = x_{t-1}\)

More generally, let \(L^k x_t = x_{t-k}\) with \(L^0 x_t = x_t\) and

\[d(L) = d_0 + d_1 L+ \ldots + d_m L^m\]

where \(d_0, d_1, \ldots, d_m\) is a given scalar sequence

Consider the discrete time control problem

(1)\[\max_{\{y_t\}} \lim_{N \to \infty} \sum^N_{t=0} \beta^t\, \left\{ a_t y_t - {1 \over 2}\, hy^2_t - {1 \over 2} \, \left[ d(L)y_t \right]^2 \right\},\]


  • \(h\) is a positive parameter and \(\beta \in (0,1)\) is a discount factor
  • \(\{a_t\}_{t \geq 0}\) is a sequence of exponential order less than \(\beta^{-1/2}\), by which we mean \(\lim_{t \rightarrow \infty} \beta^{\frac{t}{2}} a_t = 0\)

Maximization in (1) is subject to initial conditions for \(y_{-1}, y_{-2} \ldots, y_{-m}\)

Maximization is over infinite sequences \(\{y_t\}_{t \geq 0}\)


The formulation of the LQ problem given above is broad enough to encompass many useful models

As a simple illustration, recall that in LQ Dynamic Programming Problems we consider a monopolist facing stochastic demand shocks and adjustment costs

Let’s consider a deterministic version of this problem, where the monopolist maximizes the discounted sum

\[\sum_{t=0}^{\infty} \beta^t \pi_t\]


\[\pi_t = p_t q_t - c q_t - \gamma (q_{t+1} - q_t)^2 \quad \text{with} \quad p_t = \alpha_0 - \alpha_1 q_t + d_t\]

In this expression, \(q_t\) is output, \(c\) is average cost of production, and \(d_t\) is a demand shock

The term \(\gamma (q_{t+1} - q_t)^2\) represents adjustment costs

You will be able to confirm that the objective function can be rewritten as (1) when

  • \(a_t := \alpha_0 + d_t - c\)
  • \(h := 2 \alpha_1\)
  • \(d(L) := \sqrt{2 \gamma}(I - L)\)

Further examples of this problem for factor demand, economic growth, and government policy problems are given in ch. IX of [Sar87]

Finite Horizon Theory

We first study a finite \(N\) version of the problem

Later we will study an infinite horizon problem solution as a limiting version of a finite horizon problem

(This will require being careful because the limits as \(N \to \infty\) of the necessary and sufficient conditions for maximizing finite \(N\) versions of (1) are not sufficient for maximizing (1))

We begin by

  1. fixing \(N > m\),
  2. differentiating the finite version of (1) with respect to \(y_0, y_1, \ldots, y_N\), and
  3. setting these derivatives to zero

For \(t=0, \ldots, N-m\) these first-order necessary conditions are the Euler equations

For \(t = N-m + 1, \ldots, N\), the first-order conditions are a set of terminal conditions

Consider the term

\[\begin{split}\begin{aligned} J & = \sum^N_{t=0} \beta^t [d(L) y_t] [d(L) y_t] \\ & = \sum^N_{t=0} \beta^t \, (d_0 \, y_t + d_1 \, y_{t-1} + \cdots + d_m \, y_{t-m}) \, (d_0 \, y_t + d_1 \, y_{t-1} + \cdots + d_m\, y_{t-m}) \end{aligned}\end{split}\]

Differentiating \(J\) with respect to \(y_t\) for \(t=0,\ 1,\ \ldots,\ N-m\) gives

\[\begin{split}\begin{aligned} {\partial {J} \over \partial y_t} & = 2 \beta^t \, d_0 \, d(L)y_t + 2 \beta^{t+1} \, d_1\, d(L)y_{t+1} + \cdots + 2 \beta^{t+m}\, d_m\, d(L) y_{t+m} \\ & = 2\beta^t\, \bigl(d_0 + d_1 \, \beta L^{-1} + d_2 \, \beta^2\, L^{-2} + \cdots + d_m \, \beta^m \, L^{-m}\bigr)\, d (L) y_t\ \end{aligned}\end{split}\]

We can write this more succinctly as

(2)\[{\partial {J} \over \partial y_t} = 2 \beta^t \, d(\beta L^{-1}) \, d (L) y_t\]

Differentiating \(J\) with respect to \(y_t\) for \(t = N-m + 1, \ldots, N\) gives

(3)\[\begin{aligned} {\partial J \over \partial y_N} &= 2 \beta^N\, d_0 \, d(L) y_N \cr {\partial J \over \partial y_{N-1}} &= 2\beta^{N-1} \,\bigl[d_0 + \beta \, d_1\, L^{-1}\bigr] \, d(L)y_{N-1} \cr \vdots & \quad \quad \vdots \cr {\partial {J} \over \partial y_{N-m+1}} &= 2 \beta^{N-m+1}\,\bigl[d_0 + \beta L^{-1} \,d_1 + \cdots + \beta^{m-1}\, L^{-m+1}\, d_{m-1}\bigr] d(L)y_{N-m+1} \end{aligned}\]

With these preliminaries under our belts, we are ready to differentiate (1)

Differentiating (1) with respect to \(y_t\) for \(t=0, \ldots, N-m\) gives the Euler equations

(4)\[\bigl[h+d\,(\beta L^{-1})\,d(L)\bigr] y_t = a_t, \quad t=0,\, 1,\, \ldots, N-m\]

The system of equations (4) form a \(2 \times m\) order linear difference equation that must hold for the values of \(t\) indicated.

Differentiating (1) with respect to \(y_t\) for \(t = N-m + 1, \ldots, N\) gives the terminal conditions

(5)\[\begin{aligned} \beta^N (a_N - hy_N - d_0\,d(L)y_N) &= 0 \cr \beta^{N-1} \left(a_{N-1}-hy_{N-1}-\Bigl(d_0 + \beta \, d_1\, L^{-1}\Bigr)\, d(L)\, y_{N-1}\right) & = 0 \cr \vdots & \vdots\cr \beta^{N-m+1} \biggl(a_{N-m+1} - h y_{N-m+1} -(d_0+\beta L^{-1} d_1+\cdots\ +\beta^{m-1} L^{-m+1} d_{m-1}) d(L) y_{N-m+1}\biggr) & = 0 \end{aligned}\]

In the finite \(N\) problem, we want simultaneously to solve (4) subject to the \(m\) initial conditions \(y_{-1}, \ldots, y_{-m}\) and the \(m\) terminal conditions (5)

These conditions uniquely pin down the solution of the finite \(N\) problem

That is, for the finite \(N\) problem, conditions (4) and (5) are necessary and sufficient for a maximum, by concavity of the objective function

Next we describe how to obtain the solution using matrix methods

Matrix Methods

Let’s look at how linear algebra can be used to tackle and shed light on the finite horizon LQ control problem

A Single Lag Term

Let’s begin with the special case in which \(m=1\)

We want to solve the system of \(N+1\) linear equations

(6)\[\begin{aligned} \bigl[h & + d\, (\beta L^{-1})\, d\, (L) ] y_t = a_t, \quad t = 0,\ 1,\ \ldots,\, N-1\cr \beta^N & \bigl[a_N-h\, y_N-d_0\, d\, (L) y_N\bigr] = 0 \end{aligned}\]

where \(d(L) = d_0 + d_1 L\)

These equations are to be solved for \(y_0, y_1, \ldots, y_N\) as functions of \(a_0, a_1, \ldots, a_N\) and \(y_{-1}\)


\[\phi (L) = \phi_0 + \phi_1 L + \beta \phi_1 L^{-1} = h + d (\beta L^{-1}) d(L) = (h + d_0^2 + d_1^2) + d_1 d_0 L+ d_1 d_0 \beta L^{-1}\]

Then we can represent (6) as the matrix equation

(7)\[\left[ \begin{matrix} (\phi_0-d_1^2) & \phi_1 & 0 & 0 & \ldots & \ldots & 0 \cr \beta \phi_1 & \phi_0 & \phi_1 & 0 & \ldots & \dots & 0 \cr 0 & \beta \phi_1 & \phi_0 & \phi_1 & \ldots & \ldots & 0 \cr \vdots &\vdots & \vdots & \ddots & \vdots & \vdots & \vdots \cr 0 & \ldots & \ldots & \ldots & \beta \phi_1 & \phi_0 &\phi_1 \cr 0 & \ldots & \ldots & \ldots & 0 & \beta \phi_1 & \phi_0 \end{matrix} \right] \left [ \begin{matrix} y_N \cr y_{N-1} \cr y_{N-2} \cr \vdots \cr y_1 \cr y_0 \end{matrix} \right ] = \left[ \begin{matrix} a_N \cr a_{N-1} \cr a_{N-2} \cr \vdots \cr a_1 \cr a_0 - \phi_1 y_{-1} \end{matrix} \right]\]


(8)\[W\bar y = \bar a\]

Notice how we have chosen to arrange the \(y_t\)’s in reverse time order.

The matrix \(W\) on the left side of (7) is “almost” a Toeplitz matrix (where each descending diagonal is constant)

There are two sources of deviation from the form of a Toeplitz matrix

  1. The first element differs from the remaining diagonal elements, reflecting the terminal condition
  2. The subdiagonal elements equal \(\beta\) time the superdiagonal elements

The solution of (8) can be expressed in the form

(9)\[\bar y = W^{-1} \bar a\]

which represents each element \(y_t\) of \(\bar y\) as a function of the entire vector \(\bar a\)

That is, \(y_t\) is a function of past, present, and future values of \(a\)‘s, as well as of the initial condition \(y_{-1}\)

An Alternative Representation

An alternative way to express the solution to (7) or (8) is in so called feedback-feedforward form

The idea here is to find a solution expressing \(y_t\) as a function of past \(y\)‘s and current and future \(a\)‘s

To achieve this solution, one can use an LU decomposition of \(W\)

There always exists a decomposition of \(W\) of the form \(W= LU\) where

  • \(L\) is an \((N+1) \times (N+1)\) lower trangular matrix
  • \(U\) is an \((N+1) \times (N+1)\) upper trangular matrix.

The factorization can be normalized so that the diagonal elements of \(U\) are unity

Using the LU representation in (9), we obtain

(10)\[U \bar y = L^{-1} \bar a\]

Since \(L^{-1}\) is lower trangular, this representation expresses \(y_t\) as a function of

  • lagged \(y\)‘s (via the term \(U \bar y\)), and
  • current and future \(a\)’s (via the term \(L^{-1} \bar a\))

Because there are zeros everywhere in the matrix on the left of (7) except on the diagonal, superdiagonal, and subdiagonal, the \(LU\) decomposition takes

  • \(L\) to be zero except in the diagional and the leading subdiagonal
  • \(U\) to be zero except on the diagonal and the superdiagional

Thus, (10) has the form

\[\left[ \begin{matrix} 1& U_{12} & 0 & 0 & \ldots & 0 & 0 \cr 0 & 1 & U_{23} & 0 & \ldots & 0 & 0 \cr 0 & 0 & 1 & U_{34} & \ldots & 0 & 0 \cr 0 & 0 & 0 & 1 & \ldots & 0 & 0\cr \vdots & \vdots & \vdots & \vdots & \ddots & \vdots & \vdots\cr 0 & 0 & 0 & 0 & \ldots & 1 & U_{N,N+1} \cr 0 & 0 & 0 & 0 & \ldots & 0 & 1 \end{matrix} \right] \ \ \ \left[ \begin{matrix} y_N \cr y_{N-1} \cr y_{N-2} \cr y_{N-3} \cr \vdots \cr y_1 \cr y_0 \end{matrix} \right] =\]
\[\quad \left[ \begin{matrix} L^{-1}_{11} & 0 & 0 & \ldots & 0 \cr L^{-1}_{21} & L^{-1}_{22} & 0 & \ldots & 0 \cr L^{-1}_{31} & L^{-1}_{32} & L^{-1}_{33}& \ldots & 0 \cr \vdots & \vdots & \vdots & \ddots & \vdots\cr L^{-1}_{N,1} & L^{-1}_{N,2} & L^{-1}_{N,3} & \ldots & 0 \cr L^{-1}_{N+1,1} & L^{-1}_{N+1,2} & L^{-1}_{N+1,3} & \ldots & L^{-1}_{N+1\, N+1} \end{matrix} \right] \left[ \begin{matrix} a_N \cr a_{N-1} \cr a_{N-2} \cr \vdots \cr a_1 \cr a_0 - \phi_1 y_{-1} \end{matrix} \right ]\]

where \(L^{-1}_{ij}\) is the \((i,j)\) element of \(L^{-1}\) and \(U_{ij}\) is the \((i,j)\) element of \(U\)

Note how the left side for a given \(t\) involves \(y_t\) and one lagged value \(y_{t-1}\) while the right side involves all future values of the forcing process \(a_t, a_{t+1}, \ldots, a_N\)

Additional Lag Terms

We briefly indicate how this approach extends to the problem with \(m > 1\)

Assume that \(\beta = 1\) and let \(D_{m+1}\) be the \((m+1) \times (m+1)\) symmetric matrix whose elements are determined from the following formula:

\[D_{jk} = d_0 d_{k-j} + d_1 d_{k-j+1} + \ldots + d_{j-1} d_{k-1}, \qquad k \geq j\]

Let \(I_{m+1}\) be the \((m+1) \times (m+1)\) identity matrix

Let \(\phi_j\) be the coefficients in the expansion \(\phi (L) = h + d (L^{-1}) d (L)\)

Then the first order conditions (4) and (5) can be expressed as:

\[(D_{m+1} + hI_{m+1})\ \ \left[ \begin{matrix} y_N \cr y_{N-1} \cr \vdots \cr y_{N-m} \end{matrix} \right]\ = \ \left[ \begin{matrix} a_N \cr a_{N-1} \cr \vdots \cr a_{N-m} \end{matrix} \right] + M\ \left[ \begin{matrix} y_{N-m+1}\cr y_{N-m-2}\cr \vdots\cr y_{N-2m} \end{matrix} \right]\]

where \(M\) is \((m+1)\times m\) and

\[\begin{split}M_{ij} = \begin{cases} D_{i-j,\,m+1} \textrm{ for } i>j \\ 0 \textrm{ for } i\leq j\end{cases}\end{split}\]
\[\begin{aligned} \phi_m y_{N-1} &+ \phi_{m-1} y_{N-2} + \ldots + \phi_0 y_{N-m-1} + \phi_1 y_{N-m-2} +\cr &\hskip.75in \ldots + \phi_m y_{N-2m-1} = a_{N-m-1} \cr \phi_m y_{N-2} &+ \phi_{m-1} y_{N-3} + \ldots + \phi_0 y_{N-m-2} + \phi_1 y_{N-m-3} +\cr &\hskip.75in \ldots + \phi_m y_{N-2m-2} = a_{N-m-2} \cr &\qquad \vdots \cr \phi_m y_{m+1} &+ \phi_{m-1} y_m + + \ldots + \phi_0 y_1 + \phi_1 y_0 + \phi_m y_{-m+1} = a_1 \cr \phi_m y_m + \phi_{m-1}& y_{m-1} + \phi_{m-2} + \ldots + \phi_0 y_0 + \phi_1 y_{-1} + \ldots + \phi_m y_{-m} = a_0 \end{aligned}\]

As before, we can express this equation as \(W \bar y = \bar a\)

The matrix on the left of this equation is “almost” Toeplitz, the exception being the leading \(m \times m\) sub matrix in the upper left hand corner

We can represent the solution in feedback-feedforward form by obtaining a decomposition \(LU = W\), and obtain

(11)\[U \bar y = L^{-1} \bar a\]
\[\begin{aligned} \sum^t_{j=0}\, U_{-t+N+1,\,-t+N+j+1}\,y_{t-j} &= \sum^{N-t}_{j=0}\, L_{-t+N+1,\, -t+N+1-j}\, \bar a_{t+j}\ ,\cr &\qquad t=0,1,\ldots, N \end{aligned}\]

where \(L^{-1}_{t,s}\) is the element in the \((t,s)\) position of \(L\), and similarly for \(U\)

The left side of equation (11) is the “feedback” part of the optimal control law for \(y_t\), while the right-hand side is the “feedforward” part

We note that there is a different control law for each \(t\)

Thus, in the finite horizon case, the optimal control law is time dependent

It is natural to suspect that as \(N \rightarrow\infty\), (11) becomes equivalent to the solution of our infinite horizon problem, which below we shall show can be expressed as

\[c(L) y_t = c (\beta L^{-1})^{-1} a_t\ ,\]

so that as \(N \rightarrow \infty\) we expect that for each fixed \(t, U^{-1}_{t, t-j} \rightarrow c_j\) and \(L_{t,t+j}\) approaches the coefficient on \(L^{-j}\) in the expansion of \(c(\beta L^{-1})^{-1}\)

This suspicion is true under general conditions that we shall study later

For now, we note that by creating the matrix \(W\) for large \(N\) and factoring it into the \(LU\) form, good approximations to \(c(L)\) and \(c(\beta L^{-1})^{-1}\) can be obtained

The Infinite Horizon Limit

For the infinite horizon problem, we propose to discover first-order necessary conditions by taking the limits of (4) and (5) as \(N \to \infty\)

This approach is valid, and the limits of (4) and (5) as \(N\) approaches infinity are first-order necessary conditions for a maximum

However, for the infinite horizon problem with \(\beta < 1\), the limits of (4) and (5) are, in general, not sufficient for a maximum

That is, the limits of (5) do not provide enough information uniquely to determine the solution of the Euler equation (4) that maximizes (1)

As we shall see below, a side condition on the path of \(y_t\) that together with (4) is sufficient for an optimum is

(12)\[\sum^\infty_{t=0}\ \beta^t\, hy^2_t < \infty\]

All paths that satisfy the Euler equations, except the one that we shall select below, violate this condition and, therefore, evidently lead to (much) lower values of (1) than does the optimal path selected by the solution procedure below

Consider the characteristic equation associated with the Euler equation

(13)\[h+d \, (\beta z^{-1})\, d \, (z) = 0\]

Notice that if \(\tilde z\) is a root of equation (13), then so is \(\beta \tilde z^{-1}\)

Thus, the roots of (13) come in “\(\beta\)-reciprocal” pairs

Assume that the roots of (13) are distinct

Let the roots be, in descending order according to their moduli, \(z_1, z_2, \ldots, z_{2m}\)

From the reciprocal pairs property and the assumption of distinct roots, it follows that \(\vert z_j \vert > \sqrt \beta\ \hbox{ for } j\leq m \hbox { and } \vert z_j \vert < \sqrt\beta\ \hbox { for } j > m\)

It also follows that \(z_{2m-j} = \beta z^{-1}_{j+1}, j=0, 1, \ldots, m-1\)

Therefore, the characteristic polynomial on the left side of (13) can be expressed as

(14)\[\begin{aligned} h+d(\beta z^{-1})d(z) &= z^{-m} z_0(z-z_1)\cdots (z-z_m)(z-z_{m+1}) \cdots (z-z_{2m}) \cr &= z^{-m} z_0 (z-z_1)(z-z_2)\cdots (z-z_m)(z-\beta z_m^{-1}) \cdots (z-\beta z^{-1}_2)(z-\beta z_1^{-1}) \end{aligned}\]

where \(z_0\) is a constant

In (14), we substitute \((z-z_j) = -z_j (1- {1 \over z_j}z)\) and \((z-\beta z_j^{-1}) = z(1 - {\beta \over z_j} z^{-1})\) for \(j = 1, \ldots, m\) to get

\[h+d(\beta z^{-1})d(z) = (-1)^m(z_0z_1\cdots z_m) (1- {1\over z_1} z) \cdots (1-{1\over z_m} z)(1- {1\over z_1} \beta z^{-1}) \cdots(1-{1\over z_m} \beta z^{-1})\]

Now define \(c(z) = \sum^m_{j=0} c_j \, z^j\) as

(15)\[c\,(z)=\Bigl[(-1)^m z_0\, z_1 \cdots z_m\Bigr]^{1/2} (1-{z\over z_1}) \, (1-{z\over z_2}) \cdots (1- {z\over z_m})\]

Notice that (14) can be written

(16)\[h + d \ (\beta z^{-1})\ d\ (z) = c\,(\beta z^{-1})\,c\,(z)\]

It is useful to write (15) as

(17)\[c(z) = c_0(1-\lambda_1\, z) \ldots (1-\lambda_m z)\]


\[c_0 = \left[(-1)^m\, z_0\, z_1 \cdots z_m\right]^{1/2}; \quad \lambda_j={1 \over z_j},\,\ j=1, \ldots, m\]

Since \(\vert z_j \vert > \sqrt \beta \hbox { for } j = 1, \ldots, m\) it follows that \(\vert \lambda_j \vert < 1/\sqrt \beta\) for \(j = 1, \ldots, m\)

Using (17), we can express the factorization (16) as

\[h+d (\beta z^{-1})d(z) = c^2_0 (1-\lambda_1 z) \cdots (1 - \lambda_m z) (1-\lambda_1 \beta z^{-1}) \cdots (1 - \lambda_m \beta z^{-1})\]

In sum, we have constructed a factorization (16) of the characteristic polynominal for the Euler equation in which the zeros of \(c(z)\) exceed \(\beta^{1/2}\) in modulus, and the zeros of \(c\,(\beta z^{-1})\) are less than \(\beta^{1/2}\) in modulus

Using (16), we now write the Euler equation as

\[c(\beta L^{-1})\,c\,(L)\, y_t = a_t\]

The unique solution of the Euler equation that satisfies condition (12) is

(18)\[c(L)\,y_t = c\,(\beta L^{-1})^{-1}a_t\]

This can be established by using an argument paralleling that in chapter IX of [Sar87]

To exhibit the solution in a form paralleling that of [Sar87], we use (17) to write (18) as

(19)\[(1-\lambda_1 L) \cdots (1 - \lambda_mL)y_t = {c^{-2}_0 a_t \over (1-\beta \lambda_1 L^{-1}) \cdots (1 - \beta \lambda_m L^{-1})}\]

Using partial fractions, we can write the characteristic polynomial on the right side of (19) as

\[\sum^m_{j=1} {A_j \over 1 - \lambda_j \, \beta L^{-1}} \quad \text{where} \quad A_j := {c^{-2}_0 \over \prod_{i \not= j}(1-{\lambda_i \over \lambda_j})}\]

Then (19) can be written

\[(1-\lambda_1 L) \cdots (1-\lambda_m L) y_t = \sum^m_{j=1} \, {A_j \over 1 - \lambda_j \, \beta L^{-1}} a_t\]


(20)\[(1 - \lambda_1 L) \cdots (1 - \lambda_m L) y_t = \sum^m_{j=1}\, A_j \sum^\infty_{k=0}\, (\lambda_j\beta)^k\, a_{t+k}\]

Equation (20) expresses the optimum sequence for \(y_t\) in terms of \(m\) lagged \(y\)‘s, and \(m\) weighted infinite geometric sums of future \(a_t\)‘s

Furthermore, (20) is the unique solution of the Euler equation that satisfies the initial conditions and condition (12)

In effect, condition (12) compels us to solve the “unstable” roots of \(h+d (\beta z^{-1})d(z)\) forward (see [Sar87])

The step of factoring the polynomial \(h+d (\beta z^{-1})\, d(z)\) into \(c\, (\beta z^{-1})c\,(z)\), where the zeros of \(c\,(z)\) all have modulus exceeding \(\sqrt\beta\), is central to solving the problem

We note two features of the solution (20)

  • Since \(\vert \lambda_j \vert < 1/\sqrt \beta\) for all \(j\), it follows that \((\lambda_j \ \beta) < \sqrt \beta\)
  • The assumption that \(\{ a_t \}\) is of exponential order less than \(1 /\sqrt \beta\) is sufficient to guarantee that the geometric sums of future \(a_t\)‘s on the right side of (20) converge

We immediately see that those sums will converge under the weaker condition that \(\{ a_t\}\) is of exponential order less than \(\phi^{-1}\) where \(\phi = \max \, \{\beta \lambda_i, i=1,\ldots,m\}\)

Note that with \(a_t\) identically zero, (20) implies that in general \(\vert y_t \vert\) eventually grows exponentially at a rate given by \(\max_i \vert \lambda_i \vert\)

The condition \(\max_i \vert \lambda_i \vert <1 /\sqrt \beta\) guarantees that condition (12) is satisfied

In fact, \(\max_i \vert \lambda_i \vert < 1 /\sqrt \beta\) is a necessary condition for (12) to hold

Were (12) not satisfied, the objective function would diverge to \(- \infty\), implying that the \(y_t\) path could not be optimal

For example, with \(a_t = 0\), for all \(t\), it is easy to describe a naive (nonoptimal) policy for \(\{y_t, t\geq 0\}\) that gives a finite value of (17)

We can simply let \(y_t = 0 \hbox { for } t\geq 0\)

This policy involves at most \(m\) nonzero values of \(hy^2_t\) and \([d(L)y_t]^2\), and so yields a finite value of (1)

Therefore it is easy to dominate a path that violates (12)

Undiscounted Problems

It is worthwhile focusing on a special case of the LQ problems above: the undiscounted problem that emerges when \(\beta = 1\)

In this case, the Euler equation is

\[\Bigl( h + d(L^{-1})d(L) \Bigr)\, y_t = a_t\]

The factorization of the characteristic polynomial (16) becomes

\[\Bigl(h+d \, (z^{-1})d(z)\Bigr) = c\,(z^{-1})\, c\,(z)\]


\[\begin{aligned} c\,(z) &= c_0 (1 - \lambda_1 z) \ldots (1 - \lambda_m z) \cr c_0 &= \Bigl[(-1)^m z_0 z_1 \ldots z_m\Bigr ] \cr \vert \lambda_j \vert &< 1 \, \hbox { for } \, j = 1, \ldots, m\cr \lambda_j &= \frac{1}{z_j} \hbox{ for } j=1,\ldots, m\cr z_0 &= \hbox{ constant} \end{aligned}\]

The solution of the problem becomes

\[(1 - \lambda_1 L) \cdots (1 - \lambda_m L) y_t = \sum^m_{j=1} A_j \sum^\infty_{k=0} \lambda^k_j a_{t+k}\]

Transforming discounted to undiscounted problem

Discounted problems can always be converted into undiscounted problems via a simple transformation

Consider problem (1) with \(0 < \beta < 1\)

Define the transformed variables

(21)\[\tilde a_t = \beta^{t/2} a_t,\ \tilde y_t = \beta^{t/2} y_t\]

Then notice that \(\beta^t\,[d\, (L) y_t ]^2=[\tilde d\,(L)\tilde y_t]^2\) with \(\tilde d \,(L)=\sum^m_{j=0} \tilde d_j\, L^j\) and \(\tilde d_j = \beta^{j/2} d_j\)

Then the original criterion function (1) is equivalent to

(22)\[\lim_{N \rightarrow \infty} \sum^N_{t=0} \{\tilde a_t\, \tilde y_t - {1 \over 2} h\,\tilde y^2_t - {1\over 2} [ \tilde d\,(L)\, \tilde y_t]^2 \}\]

which is to be maximized over sequences \(\{\tilde y_t,\ t=0, \ldots\}\) subject to \(\tilde y_{-1}, \cdots, \tilde y_{-m}\) given and \(\{\tilde a_t,\ t=1, \ldots\}\) a known bounded sequence

The Euler equation for this problem is \([h+\tilde d \,(L^{-1}) \, \tilde d\, (L) ]\, \tilde y_t = \tilde a_t\)

The solution is

\[(1 - \tilde \lambda_1 L) \cdots (1 - \tilde \lambda_m L)\,\tilde y_t = \sum^m_{j=1} \tilde A_j \sum^\infty_{k=0} \tilde \lambda^k_j \, \tilde a_{t+k}\]


(23)\[\tilde y_t = \tilde f_1 \, \tilde y_{t-1} + \cdots + \tilde f_m\, \tilde y_{t-m} + \sum^m_{j=1} \tilde A_j \sum^\infty_{k=0} \tilde \lambda^k_j \, \tilde a_{t+k},\]

where \(\tilde c \,(z^{-1}) \tilde c\,(z) = h + \tilde d\,(z^{-1}) \tilde d \,(z)\), and where

\[\bigl[(-1)^m\, \tilde z_0 \tilde z_1 \ldots \tilde z_m \bigr]^{1/2} (1 - \tilde \lambda_1\, z) \ldots (1 - \tilde \lambda_m\, z) = \tilde c\,(z), \hbox { where } \ \vert \tilde \lambda_j \vert < 1\]

We leave it to the reader to show that (23) implies the equivalent form of the solution

\[y_t = f_1\, y_{t-1} + \cdots + f_m\, y_{t-m} + \sum^m_{j=1} A_j \sum^\infty_{k=0} \, (\lambda_j\, \beta)^k \, a_{t+k}\]


(24)\[f_j = \tilde f_j\, \beta^{-j/2},\ A_j = \tilde A_j,\ \lambda_j = \tilde \lambda_j \, \beta^{-1/2}\]

The transformations (21) and the inverse formulas (24) allow us to solve a discounted problem by first solving a related undiscounted problem


Code that computes solutions to the LQ problem using the methods described above can be found in file control_and_filter.jl

Here’s how it looks


Author: Shunsuke Hori


using Polynomials

struct LQFilter{TR<:Real, TI<:Integer, TF<:AbstractFloat}

d : Vector
        The order of the coefficients: [d_0, d_1, ..., d_m]
h : Real
        Parameter of the objective function (corresponding to the
        quadratic term)
y_m : Vector
        Initial conditions for y
r : Vector
        The order of the coefficients: [r_0, r_1, ..., r_k]
        (optional, if not defined -> deterministic problem)
beta : Real or nothing
        Discount factor (optional, default value is one)
h_eps : 
function LQFilter{TR<:Real}(d::Vector{TR},

    m = length(d) - 1

    m == length(y_m) ||
        throw(ArgumentError("y_m and d must be of same length = $m"))

    # Define the coefficients of phi up front

    phi = Vector{TR}(2m + 1)
    for i in -m:m
        phi[m-i+1] = sum(diag(d*d', -i))
    phi[m+1] = phi[m+1] + h

    # If r is given calculate the vector phi_r
    if r == nothing
        phi_r = nothing
        k = size(r,1) - 1
        phi_r = Vector{TR}(2k + 1)

        for i = -k:k
            phi_r[k-i+1] = sum(diag(r*r', -i))

        if h_eps != nothing
            phi_r[k+1] = phi_r[k+1] + h_eps

    # If beta is given, define the transformed variables
    if beta == nothing
        beta = 1.0
        d = beta.^(collect(0:m)/2) * d
        y_m = y_m * beta.^(- collect(1:m)/2)

    return LQFilter(d,h,y_m,m,phi,beta,phi_r,k)

This constructs the matrices W and W_m for a given number of periods N
function construct_W_and_Wm(lqf::LQFilter, N::Integer)

    d, m = lqf.d, lqf.m

    W = zeros(N + 1, N + 1)
    W_m = zeros(N + 1, m)

    # Terminal conditions

    D_m1 = zeros(m + 1, m + 1)
    M = zeros(m + 1, m)

    # (1) Constuct the D_{m+1} matrix using the formula

    for j in 1:(m+1)
        for k in j:(m+1)
            D_m1[j, k] = dot(d[1:j,1], d[k-j+1:k,1])

    # Make the matrix symmetric
    D_m1 = D_m1 + D_m1' - diagm(diag(D_m1))

    # (2) Construct the M matrix using the entries of D_m1

    for j in 1:m
        for i in (j + 1):(m + 1)
            M[i, j] = D_m1[i-j, m+1]

    # Euler equations for t = 0, 1, ..., N-(m+1)
    phi, h = lqf.phi, lqf.h

    W[1:(m + 1), 1:(m + 1)] = D_m1 + h * eye(m + 1)
    W[1:(m + 1), (m + 2):(2m + 1)] = M

    for (i, row) in enumerate((m + 2):(N + 1 - m))
        W[row, (i + 1):(2m + 1 + i)] = phi'

    for i in 1:m
        W[N - m + i + 1 , end-(2m + 1 - i)+1:end] = phi[1:end-i]

    for i in 1:m
        W_m[N - i + 2, 1:(m - i)+1] = phi[(m + 1 + i):end]

    return W, W_m

This function calculates z_0 and the 2m roots of the characteristic equation
associated with the Euler equation (1.7)
`poly(roots)` from defines a polynomial using its roots that can be
evaluated at any point by `polyval(Poly,x)`. If x_1, x_2, ... , x_m are the roots then
    polyval(poly(roots),x) = (x - x_1)(x - x_2)...(x - x_m)
function roots_of_characteristic(lqf::LQFilter)
    m, phi = lqf.m, lqf.phi
    # Calculate the roots of the 2m-polynomial
    proots = roots(phi_poly)
    # sort the roots according to their length (in descending order)
    roots_sorted = sort(proots, by=abs)[end:-1:1]
    z_0 = sum(phi) / polyval(poly(proots), 1.0)
    z_1_to_m = roots_sorted[1:m]     # we need only those outside the unit circle
    lambdas = 1 ./ z_1_to_m
    return z_1_to_m, z_0, lambdas

This function computes the coefficients {c_j, j = 0, 1, ..., m} for
    c(z) = sum_{j = 0}^{m} c_j z^j
Based on the expression (1.9). The order is
    c_coeffs = [c_0, c_1, ..., c_{m-1}, c_m]
function coeffs_of_c(lqf::LQFilter)
    m = lqf.m
    z_1_to_m, z_0, lambdas = roots_of_characteristic(lqf)
    c_0 = (z_0 * prod(z_1_to_m) * (-1.0)^m)^(0.5)
    c_coeffs = coeffs(poly(z_1_to_m)) * z_0 / c_0
    return c_coeffs

This function calculates {lambda_j, j=1,...,m} and {A_j, j=1,...,m}
of the expression (1.15)
function solution(lqf::LQFilter)
    z_1_to_m, z_0, lambdas = roots_of_characteristic(lqf)
    c_0 = coeffs_of_c(lqf)[end]
    A = zeros(lqf.m)
    for j in 1:m
        denom = 1 - lambdas/lambdas[j]
        A[j] = c_0^(-2) / prod(denom[1:m .!= j])
    return lambdas, A

This function constructs the covariance matrix for x^N (see section 6)
for a given period N
function construct_V(lqf::LQFilter; N::Integer=nothing)
    if N == nothing
        error("N must be provided!!")
    if !(typeof(N) <: Integer)
        throw(ArgumentError("N must be Integer!"))
    phi_r, k = lqf.phi_r, lqf.k
    V = zeros(N, N)
    for i in 1:N
        for j in 1:N
            if abs(i-j) <= k
                V[i, j] = phi_r[k + abs(i-j)+1]
    return V

Assuming that the u's are normal, this method draws a random path
for x^N
function simulate_a(lqf::LQFilter, N::Integer)
    V = construct_V(N + 1)
    d = MVNSampler(zeros(N + 1), V)
    return rand(d)

This function implements the prediction formula discussed is section 6 (1.59)
It takes a realization for a^N, and the period in which the prediciton is formed

Output:  E[abar | a_t, a_{t-1}, ..., a_1, a_0]
function predict(lqf::LQFilter, a_hist::Vector, t::Integer)
    N = length(a_hist) - 1
    V = construct_V(N + 1)

    aux_matrix = zeros(N + 1, N + 1)
    aux_matrix[1:t+1 , 1:t+1 ] = eye(t + 1)
    L = chol(V)'
    Ea_hist = inv(L) * aux_matrix * L * a_hist

    return Ea_hist

- if t is NOT given it takes a_hist (Vector or Array) as a deterministic a_t
- if t is given, it solves the combined control prediction problem (section 7)
 (by default, t == nothing -> deterministic)

for a given sequence of a_t (either determinstic or a particular realization),
it calculates the optimal y_t sequence using the method of the lecture

lufact normalizes L, U so that L has unit diagonal elements
To make things cosistent with the lecture, we need an auxiliary diagonal
matrix D which renormalizes L and U

function optimal_y(lqf::LQFilter, a_hist::Vector, t = nothing)
    beta, y_m, m = lqf.beta, lqf.y_m, lqf.m

    N = length(a_hist) - 1
    W, W_m = construct_W_and_Wm(lqf, N)

    F = lufact(W, Val{true})

    L, U = F[:L], F[:U]
    D = diagm(1.0./diag(U))
    U = D * U
    L = L * diagm(1.0./diag(D))

    J = flipdim(eye(N + 1), 2)

    if t == nothing   # if the problem is deterministic
        a_hist = J * a_hist

        # Transform the a sequence if beta is given
        if beta != 1
            a_hist =  reshape(a_hist * (beta^(collect(N:0)/ 2)),N + 1, 1)

        a_bar = a_hist - W_m * y_m           # a_bar from the lecutre
        Uy = \(L, a_bar)            # U @ y_bar = L^{-1}a_bar from the lecture
        y_bar = \(U, Uy)            # y_bar = U^{-1}L^{-1}a_bar
        # Reverse the order of y_bar with the matrix J
        J = flipdim(eye(N + m + 1), 2)
        y_hist = J * vcat(y_bar, y_m)     # y_hist : concatenated y_m and y_bar
        # Transform the optimal sequence back if beta is given
        if beta != 1
            y_hist = y_hist .* beta.^(- collect(-m:N)/2)

    else           # if the problem is stochastic and we look at it
        Ea_hist = reshape(predict(a_hist, t), N + 1, 1)
        Ea_hist = J * Ea_hist

        a_bar = Ea_hist - W_m * y_m           # a_bar from the lecutre
        Uy = \(L, a_bar)            # U @ y_bar = L^{-1}a_bar from the lecture
        y_bar = \(U, Uy)            # y_bar = U^{-1}L^{-1}a_bar

        # Reverse the order of y_bar with the matrix J
        J = flipdim(eye(N + m + 1), 2)
        y_hist = J * vcat(y_bar, y_m)     # y_hist : concatenated y_m and y_bar
    return y_hist, L, U, y_bar


In this application we’ll have one lag, with

\[d(L) y_t = \gamma(I - L) y_t = \gamma (y_t - y_{t-1})\]

Suppose for the moment that \(\gamma = 0\)

Then the intertemporal component of the LQ problem disappears, and the agent simply wants to maximize \(a_t y_t - hy^2_t / 2\) in each period

This means that the agent chooses \(y_t = a_t / h\)

In the following we’ll set \(h = 1\), so that the agent just wants to track the \(\{a_t\}\) process

However, as we increase \(\gamma\), the agent gives greater weight to a smooth time path

Hence \(\{y_t\}\) evolves as a smoothed version of \(\{a_t\}\)

The \(\{a_t\}\) sequence we’ll choose as a stationary cyclic process plus some white noise

Here’s some code that generates a plot when \(\gamma = 0.8\)

using PyPlot
# == Set seed and generate a_t sequence == #
n = 100
a_seq = sin.(linspace(0, 5*pi, n)) + 2 + 0.1 * randn(n)

# == Model parameters == #
gamma = 0.8
m = 1
d = gamma * [1, -1]
h = 1.0

# == Initial conditions == #
y_m = [2.0]

testlq = LQFilter(d, h, y_m)
y_hist, L, U, y = optimal_y(testlq, a_seq)
y = y[end:-1:1]  # reverse y

# == Plot simulation results == #
fig, ax = subplots(figsize=(10, 6.1))

# == Some fancy plotting stuff -- simplify if you prefer == #
bbox = (0., 1.01, 1., .101)

time = 1:length(y)
ax[:set_xlim](0, maximum(time))
ax[:plot](time, a_seq / h, "k-o", ms=4, lw=2, alpha=0.6, label=L"$a_t$")
ax[:plot](time, y, "b-o", ms=4, lw=2, alpha=0.6, label=L"$y_t$")
ax[:legend](ncol=2, bbox_to_anchor= bbox, loc = 3, mode = "expand", fontsize= 16)

Here’s the figure that it generates


Here’s what happens when we change \(\gamma\) to 5.0


And here’s \(\gamma = 10\)



Exercise 1

Consider solving a discounted version \((\beta < 1)\) of problem (1), as follows

Convert (1) to the undiscounted problem (22)

Let the solution of (22) in feedback form be

\[(1 - \tilde \lambda_1 L)\, \cdots\, (1 - \tilde \lambda_m L) \tilde y_t = \sum^m_{j=1} \tilde A_j \sum^\infty_{k=0} \tilde \lambda^k_j \tilde a_{t+k}\]


(25)\[\tilde y_t = \tilde f_1 \tilde y_{t-1} + \cdots + \tilde f_m \tilde y_{t-m} + \sum^m_{j=1} \tilde A_j \sum^\infty_{k=0} \tilde \lambda^k_j \tilde a_{t+k}\]


  • \(h + \tilde d (z^{-1}) \tilde d (z) = \tilde c (z^{-1}) \tilde c (z)\)
  • \(\tilde c (z) = [(-1)^m \tilde z_0 \tilde z_1 \cdots \tilde z_m ]^{1/2} (1 - \tilde \lambda_1 z) \cdots (1 - \tilde \lambda_m z)\)

where the \(\tilde z_j\) are the zeros of \(h +\tilde d (z^{-1})\, \tilde d(z)\)

Prove that (25) implies that the solution for \(y_t\) in feedback form is

\[y_t = f_1 y_{t-1} + \ldots + f_m y_{t-m} + \sum^m_{j=1} A_j \sum^\infty_{k=0} \beta^k \lambda^k_j a_{t+k}\]

where \(f_j = \tilde f_j \beta^{-j/2}, A_j = \tilde A_j\), and \(\lambda_j = \tilde \lambda_j \beta^{-1/2}\)

Exercise 2

Solve the optimal control problem, maximize

\[\sum^2_{t=0}\ \Bigl\{a_t y_t - {1 \over 2} [(1 - 2 L) y_t]^2\Bigr\}\]

subject to \(y_{-1}\) given, and \(\{ a_t\}\) a known bounded sequence

Express the solution in the “feedback form” (20), giving numerical values for the coefficients

Make sure that the boundary conditions (5) are satisfied

(Note: this problem differs from the problem in the text in one important way: instead of \(h > 0\) in (1), \(h = 0\). This has an important influence on the solution.)

Exercise 3

Solve the infinite time optimal control problem to maximize

\[\lim_{N \rightarrow \infty} \sum^N_{t=0}\, -\, {1 \over 2} [(1 -2 L) y_t]^2,\]

subject to \(y_{-1}\) given. Prove that the solution is

\[y_t = 2y_{t-1} = 2^{t+1} y_{-1} \qquad t > 0\]

Exercise 4

Solve the infinite time problem, to maximize

\[\lim_{N \rightarrow \infty}\ \sum^N_{t=0}\ (.0000001)\, y^2_t - {1 \over 2} [(1 - 2 L) y_t]^2\]

subject to \(y_{-1}\) given. Prove that the solution \(y_t = 2y_{t-1}\) violates condition (12), and so is not optimal

Prove that the optimal solution is approximately \(y_t = .5 y_{t-1}\)