Optimal Dividend Payout under Stochastic Discounting

TL;DR

This paper derives an optimal dividend payout strategy for a firm with surplus modeled by an arithmetic Brownian motion, considering stochastic discount rates governed by a CIR process, and characterizes the value function via a variational inequality.

Contribution

It introduces a novel stochastic control framework for dividend payout under stochastic discounting, with an explicit threshold policy depending on the interest rate.

Findings

Optimal dividend threshold is a decreasing function of the interest rate.

The value function solves a variational inequality with a gradient constraint.

The policy maximizes expected discounted dividends until insolvency.

Abstract

Adopting a probabilistic approach we determine the optimal dividend payout policy of a firm whose surplus process follows a controlled arithmetic Brownian motion and whose cash-flows are discounted at a stochastic dynamic rate. Dividends can be paid to shareholders at unrestricted rates so that the problem is cast as one of singular stochastic control. The stochastic interest rate is modelled by a Cox-Ingersoll-Ross (CIR) process and the firm's objective is to maximize the total expected flow of discounted dividends until a possible insolvency time. We find an optimal dividend payout policy which is such that the surplus process is kept below an endogenously determined stochastic threshold expressed as a decreasing continuous function $r \mapsto b(r)$ of the current interest rate value. We also prove that the value function of the singular control problem solves a variational inequality associated to a second-order, non-degenerate elliptic operator, with a gradient constraint.