Optimal dividend distribution under Markov-regime switching

TL;DR

This paper studies optimal dividend strategies for a company with revenues influenced by regime shifts, showing barrier strategies are optimal under positive drifts and providing explicit solutions and numerical insights.

Contribution

It introduces regime-dependent barrier strategies for dividend distribution in a Markov-modulated revenue model, with explicit characterization and analysis of different drift scenarios.

Findings

Optimal barrier strategies are identified for positive drifts in all regimes.

Explicit characterization of the value function as a fixed point of a contraction.

Numerical analysis illustrates the impact of regime switching on optimal barriers.

Abstract

We investigate the problem of optimal dividend distribution for a company in the presence of regime shifts. We consider a company whose cumulative net revenues evolve as a Brownian motion with positive drift that is modulated by a finite state Markov chain, and model the discount rate as a deterministic function of the current state of the chain. In this setting the objective of the company is to maximize the expected cumulative discounted dividend payments until the moment of bankruptcy, which is taken to be the first time that the cash reserves (the cumulative net revenues minus cumulative dividend payments) are zero. We show that, if the drift is positive in each state, it is optimal to adopt a barrier strategy at certain positive regime-dependent levels, and provide an explicit characterization of the value function as the fixed point of a contraction. In the case that the drift is small and negative in one state, the optimal strategy takes a different form, which we explicitly identify if there are two regimes. We also provide a numerical illustration of the sensitivities of the optimal barriers and the influence of regime-switching.