Regularity of the Exercise Boundary for American Put Options on Assets with Discrete Dividends

TL;DR

This paper investigates the regularity and behavior of the optimal exercise boundary for American put options with discrete dividends, providing conditions for continuity, monotonicity, and boundary behavior near dividend dates.

Contribution

It establishes new regularity results for the exercise boundary under various dividend function assumptions, extending to multiple dividend dates.

Findings

Boundary tends to zero as time approaches dividend date from the left.

Continuity and high contact principle hold under linear dividend functions.

Results extend to multiple dividend payment dates.

Abstract

We analyze the regularity of the optimal exercise boundary for the American Put option when the underlying asset pays a discrete dividend at a known time $t_d$ during the lifetime of the option. The ex-dividend asset price process is assumed to follow Black-Scholes dynamics and the dividend amount is a deterministic function of the ex-dividend asset price just before the dividend date. The solution to the associated optimal stopping problem can be characterised in terms of an optimal exercise boundary which, in contrast to the case when there are no dividends, may no longer be monotone. In this paper we prove that when the dividend function is positive and concave, then the boundary is non-increasing in a left-hand neighbourhood of $t_d$, and tends to $0$ as time tends to $t_d^-$ with a speed that we can characterize. When the dividend function is linear in a neighbourhood of zero, then we show continuity of the exercise boundary and a high contact principle in the left-hand neighbourhood of $t_d$. When it is globally linear, then right-continuity of the boundary and the high contact principle are proved to hold globally. Finally, we show how all the previous results can be extended to multiple dividend payment dates in that case.