The existence of optimal bang-bang controls for GMxB contracts

TL;DR

This paper establishes conditions under which optimal bang-bang controls exist for GMxB contracts, simplifying the control search process by proving that optimal strategies often involve only a few discrete actions.

Contribution

The paper provides a rigorous bang-bang principle based on convexity and monotonicity, demonstrating when optimal controls for GMxB contracts are of bang-bang type.

Findings

Optimal bang-bang controls exist for GLWB contracts.

Holder's optimal actions are nonwithdrawal, withdrawal at contract rate, or full surrender.

The minimum withdrawal benefit contract generally does not satisfy the bang-bang principle.

Abstract

A large collection of financial contracts offering guaranteed minimum benefits are often posed as control problems, in which at any point in the solution domain, a control is able to take any one of an uncountable number of values from the admissible set. Often, such contracts specify that the holder exert control at a finite number of deterministic times. The existence of an optimal bang-bang control, an optimal control taking on only a finite subset of values from the admissible set, is a common assumption in the literature. In this case, the numerical complexity of searching for an optimal control is considerably reduced. However, no rigorous treatment as to when an optimal bang-bang control exists is present in the literature. We provide the reader with a bang-bang principle from which the existence of such a control can be established for contracts satisfying some simple conditions. The bang-bang principle relies on the convexity and monotonicity of the solution and is developed using basic results in convex analysis and parabolic partial differential equations. We show that a guaranteed lifelong withdrawal benefit (GLWB) contract admits an optimal bang-bang control. In particular, we find that the holder of a GLWB can maximize a writer's losses by only ever performing nonwithdrawal, withdrawal at exactly the contract rate, or full surrender. We demonstrate that the related guaranteed minimum withdrawal benefit contract is not convexity preserving, and hence does not satisfy the bang-bang principle other than in certain degenerate cases.