Stochastic Optimal Control for Jump Diffusion Models with Singular Drifts

TL;DR

This paper develops necessary and sufficient optimality conditions for jump-diffusion control problems with threshold-induced discontinuities, relevant in insurance surplus management.

Contribution

It introduces a novel approach combining Sobolev representations, smooth approximations, and Ekeland's principle to handle non-smooth dynamics outside classical SMP scope.

Findings

Established optimality conditions for jump-diffusion systems with singular drifts.

Applied results to optimal insurance premium and reserve management policies.

Demonstrated the approach's effectiveness in threshold-based intervention models.

Abstract

We study a stochastic optimal control problem for jump-diffusion systems whose drift coefficient is piecewise Lipschitz continuous and exhibits threshold-induced discontinuities. Such dynamics naturally arise in applications with intervention policies triggered by safety levels, notably in insurance surplus management with dividend payments and capital injections. These features place the problem outside the scope of classical stochastic maximum principle (SMP) results, which rely on global smoothness assumptions. We establish both necessary and sufficient optimality conditions for this class of control problems. Our approach combines a Sobolev-type representation of the first variation process with smooth approximations and Ekeland's variational principle. As application, we study an optimal premium adjustment and reserve management policies for an insurance whose surplus is modelled by threshold-based dividend and capital injection policies.