An Optimal Dividend Problem with Capital Injections over a Finite Horizon

TL;DR

This paper formulates and solves an optimal dividend and capital injection problem over a finite horizon, linking it to an optimal stopping problem for a drifted Brownian motion, with explicit boundary properties analyzed in a case study.

Contribution

It introduces a novel connection between the dividend problem with capital injections and an optimal stopping framework, providing explicit boundary characterizations.

Findings

Optimal strategies are characterized by time-dependent boundaries.

The value function's derivative relates to the stopping problem's value.

Explicit boundary properties are derived in a constant parameter case study.

Abstract

In this paper we propose and solve an optimal dividend problem with capital injections over a finite time horizon. The surplus dynamics obeys a linearly controlled drifted Brownian motion that is reflected at the origin, dividends give rise to time-dependent instantaneous marginal profits, whereas capital injections are subject to time-dependent instantaneous marginal costs. The aim is to maximize the sum of a liquidation value at terminal time and of the total expected profits from dividends, net of the total expected costs for capital injections. Inspired by the study of El Karoui and Karatzas (1989) on reflected follower problems, we relate the optimal dividend problem with capital injections to an optimal stopping problem for a drifted Brownian motion that is absorbed at the origin. We show that whenever the optimal stopping rule is triggered by a time-dependent boundary, the value function of the optimal stopping problem gives the derivative of the value function of the optimal dividend problem. Moreover, the optimal dividend strategy is also triggered by the moving boundary of the associated stopping problem. The properties of this boundary are then investigated in a case study in which instantaneous marginal profits and costs from dividends and capital injections are constants discounted at a constant rate.