On the closed-form expected NPVs of double barrier strategies for regular diffusions

TL;DR

This paper derives explicit formulas for the expected net present values of double barrier strategies in regular diffusions, avoiding differential equation solutions, and identifies conditions for optimal barrier levels.

Contribution

It introduces a method to explicitly compute expected NPVs for double barrier strategies using bivariate q-scale functions and perturbation techniques, without solving differential equations.

Findings

Explicit formulas for expected NPVs are derived.

Conditions for the existence of an optimal barrier are established.

Examples demonstrating optimal barrier selection are provided.

Abstract

The core of the research is to provide the explicit expression for the expected net present values (NPVs) of double barrier strategies for regular diffusions on the real line without solving differential equations. Under the so-called bail-out setting, the value of the expected NPVs of an insurance company varies according to the choice of a pair of policies, which consist of dividend payments paid out and capital injections received. In the case of the double barrier strategy, the expected NPVs are expressible with the help of certain types of functions allowing explicit expression in some cases, which is called the bivariate $q$-scale function in the article. This is accomplished by making use of a perturbation technique in \cite{czarna2014dividend}, which could lead to the linear equation system. In addition, a condition ensuring the existence of an optimal (upper) barrier level is presented. In the end, examples fitting the condition for selecting the optimal barrier are given.