Outrunning the Omega Clock: A Singular Control Problem for Dividend Optimisation with Ruin and Time-in-Distress Default

TL;DR

This paper models a more realistic default mechanism in dividend optimization by considering occupation-time-based default, leading to new control strategies and insights into dividend timing under distress conditions.

Contribution

It introduces a novel singular control problem incorporating occupation-time default, providing a complete analytical solution and revealing new optimal dividend strategies.

Findings

Optimal strategies vary with parameter regimes.

Disconnection of action and inaction regions can occur.

Higher discounting may delay dividends.

Abstract

This paper extends the classical dividend problem by incorporating a novel, path-dependent mechanism of firm default. In the traditional framework, ruin occurs when the surplus process first reaches zero. In contrast, default in our model may also arise when the surplus spends an excessive amount of time below a distress threshold, even without ever hitting zero. This occupation-time-based default criterion captures financial distress more realistically, as prolonged periods of low liquidity or capitalisation may trigger regulatory intervention or operational failure. The resulting optimisation problem is formulated as a new singular stochastic control problem with discontinuous state-dependent discounting and killing. We provide a complete analytical solution via a bespoke sequential guess-and-verify method and identify three distinct classes of optimal dividend strategies corresponding to different parameter regimes of the dual-ruin structure. Notably, for certain distress thresholds, the optimal policy features disconnected action and inaction regions. We further show that, unlike in the classical dividend problem, higher effective discounting induced by occupation time below a distress level can lead to delayed, rather than earlier, dividend payments.