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Russian Math. Surveys 50:2 257-277 1995 BL Board and LMS

Uspekhi Mat. Nauk 50:2 25-46 UDC 519.2

Optimization of the flow of dividends

M. Jeanblanc-Picque and A. N. Shiryaev

Contents
1. Introduction 257
2. The case A 258
3. The case 267
4. The case C 273
Bibliography 277

1. Introduction
1. In the recent papers [1], [2] Radner and Shepp considered a model of the evolution
of the capital X = (Xt)t^o of a company assuming that

dXt = + \ - dZt, (1.1)

where W = (Wt)t^o is a standard Wiener process, and the coefficients (, ) can


be chosen in a predictable way as functions of the data observed, with values in an
a priori admissible set A. The non-negative non-decreasing non-anticipating process
= (Zt)t^o appearing in (1.1) characterizes a strategy of payment of dividends by
the company.
We assume that the initial capital is non-negative, XQ = ^ 0, and after X hits
zero we have bankruptcy and dXt = dZt = 0 for t ^ , where is the moment of
bankruptcy.
As a criterion for optimal functioning of the company Radner and Shepp consider
the quantity
<
= s u p E x / e-xtdZt,
V{x) > 0 , (1.2)
Jo
where Ex is the mathematical expectation corresponding to Xo = x,

/ e-xtdZt = Z0+ erxtdZt, (1.3)


JO i((0,oo)

and sup is taken over all admissible strategies from the set A and admissible
dividend processes = (Zi)tj>o
2. In the present paper we consider the Radner-Shepp model (1.1) assuming that
the set A is one-element, A = {(,)} with > 0, > 0. We want to find optimal
dividend processes (Zt)t^o under the following assumptions on their structure.
258 . Jeanblanc-Picque and A. N. Shiryaev

. Processes = (Zt)t^o are such that

dZt = u{Xt) dt, Zo = Z0(x), (1.4)

where u = u(x), ZQ = ZQ(X) are arbitrary measurable functions satisfying


0 < u{x) < < oo, 0 < Z0(x) ^ x.
B. Processes = (Zt)t^o are such that

X T
Y t ) , (1.5)

where 0 = To < < T2 < ... are (random) moments of payments of dividends,
and 3o>3i) a r e non-negative amounts of dividends paid. In addition, we assume
that there is a fee (transaction cost) 7 > 0 for each payment and the cost function
has the form
x J2e~XT'(3l-j), (1.6)

where sup is taken over all multivariant point processes (,3)^ (see [3]).
C. The process = (Zt)t^o is a n arbitrary non-negative non-decreasing non-
anticipating process, right-continuous for t > 0.
The solution of the problem of finding the structure of the optimal payment
process given in [1], [2] in the general case C will be established below, making use
of the ideas concerned with local time and diffusion with reflection. What we do is
the same as in [1], [2], but the stochastic analysis technique is somewhat different.
The relevance of cases A and B, in addition to their natural importance, is that
they suggest the structure of optimal solution in the general case C (by the limit
passage with oo and 7 > 0 in A and B, respectively).
The results corresponding to the three cases A, B, C are presented in 2, 3, 4
respectively.

2. The case A
1. Let W (Wt)t^o be a standard Wiener process given on a filtered probability
space (,3", (3"t)t^o5 P)- We assume that the evolution of the company's capital is
described by the equation

dXt = fo-u(Xt))dt + adWt, (2.1)

where u = u(x) is an arbitrary measurable function with 0 ^ u(x) ^ < oo


[K is a given constant). We note that by Zvonkin's result [6], the stochastic dif-
ferential equation (2.1) has a unique strong solution X (Xt)t^o such that Xt are
3 = a(Ws;s ^ immeasurable, t > 0. In this way (2.1) defines the controlled
process X = Xu by means of the control u = u{x).
Drawing on the meaning of the model described in 1 we assume that ^ 0,
and if r = inf{i : Xt = 0}, then Xt(u) = 0 for all t ^ {) (formally, X = 0 on
[r, 00), see [3]). Here the equation (2.1) for X 'exists' up to the first instant of X
hitting zero.
Optimization of the flow of dividends 259

Writing (1.4) in the integral form

Zt = Z0{x)+ f u(Xs)ds, (2.2)


Jo
we find that
Xt = (x- Z0(x)) + ( - u(X,)) ds + aWt (2.3)
Jo
(for all 0 ^ t ^ ).
Let

V(x; u; Zo) = Z0(x) + E x _ Z o ( x ) e~xtu(Xt) dt, (2.4)


Jo
V(x)=supV(x;u;Z0), (2.5)

where sup is taken over all admissible u(x) and Z0(x) (0 ^ u(x) ^ A",
0 ZQ(x) < x).
It is clear that

V(a;) = max {Z0(x) + V0(x - Z0{x))}, (2.6)

where

and sup is taken over all admissible u; ZQ(X) = 0, V{x;u) = V(x;u,0).


Clearly, the most difficult task is to find the function VQ(X) and the corresponding
optimal control Uo = uo(x). This is why we now assume that ZQ = 0 and we return
to the general case in 6 below. To simplify the notation we denote Vo(x) by V(x),
omitting the index 0.
2. So, suppose that
V(x) = sup Ex I e-xtu(Xt) dt,
Jo
where sup is taken over all controls u = u(x) with 0 ^ u(x) ^ K.
Using standard techniques of stochastic control theory (see, for example, [5], [7]),
to get the required function V = V(x) and the corresponding optimal control
= () with V(x;u) = V(x), it is sufficient to establish the following testing
properties:
(Ai) there is a function V = V(x) such that for any admissible control u = u(x)

V(x;u)^V(x), x^O

(and so V(x) ^ V(x)), and


(A2) there is a control () such that

V(x;u) = V(x), x^O.


260 . Jeanblanc-Picque and A. N. Shiryaev

Clearly, if such a function V(x) exists, then V(x) = V(x) and as optimal we can
take the control u = u(x).
The function V = V(x) and control G = () can be found by means of Bellman's
equation. The verification of the properties (), (2) is usually done by means of
Ito's formula using the martingale properties of stochastic integrals.
Let us realize our plan of finding V and u. We introduce some operators L(u),
0 ^ u ^ K, acting on = (^), ^ 0, of class C 2 (0, 00), given by

. ,_ , ! 2 ,.
/() = ( - ) 1 . (2.8)

Suppose we have found a bounded function V C2(0, oo) with V(0) 0 such that
Bellman's inequality is satisfied:

sup [L(u)V(x) + u] ^ 0. (2.9)

We show that then property (Ai) is satisfied, that is, for any admissible control
u = u(x) we have V(x;u) ^ V(x), ^ 0.
To this end we apply Ito's formula to (e~xtV(Xt))t^o '
tf\T ftf\T
~ / - f 3-XsaV'(Xs)dWs.
Jo Jo
Hence, taking Ex and taking into account XQ = and (2.9), we find that

V(x) = Exe~x{tAT)V(XtAT) (2.10)

- Ex [ e-XsL(u)V(Xs) ds-Ex [ ae-XsV'{Xs) dWs


Jo Jo

tAr pt/\r
pt/\r ^

/
e~Xsu(Xs) ds-Ex dWs. ae'XsV'(Xs)
Jo
Hence we see that if V = V(x) is such that |V"'(x)| C for some constant C ^ 0,
then the stochastic integral in (2.10) is a martingale and its mathematical expec-
tation is zero.
Letting t -> 00 in (2.10) we find that
Exe~x^tA^V(XtAT) - 0
(if r < 00, then V{XT) = 0, and if = 00, then V(Xt) is bounded and - ( ' -> 0
as t -+ 00).
Thus from (2.10) we find that

V(x) ^ V(x;u),

that is, the testing condition (A2) is satisfied.


Optimization of the flow of dividends 261

3. We note that in the computations performed in (2.10) inequality appeared as a


result of the assumption that V = V(x) satisfies Bellman's inequality (2.9).
Suppose now that in (2.9) equality takes place, that is, Bellman's equation is
satisfied:
sup [L(u)V(x)+u] = 0 . (2.11)

By (2.8) this equation is equivalent to

Hence we can see that if the function V = V(x) is known, then the control
u = u(x) on which (2.12) is satisfied should be the following:

(2.13)

Using this we find from (2.12) that for such that u(x) = 0 the following
equation should hold:

'() + "()-()=0, (2.14)

and if u{x) = K, then we have


2
'{) + y V " ( i ) - XV(x) + K{1 - V'{x)) = 0. (2.15)

From the intuitive considerations about the structure of the optimal control
= () we can assume that there is an such that for ^ we have to use
() = (that is, to pay dividends with maximal possible speed if capital is
'large') and for < we put u(x) = 0 (that is, we do not pay a dividend if the
capital is 'small').
Thus, we seek the function V = V(x) and the threshold of switching the
equations as a solution to the following Stefan problem with free boundary x:

'{) + V"{x) - \V{x) =0, <x, (2.16)

(-)'() + "{)-\()+ = 0, >. (2.17)

4. For > 0 we consider the equation


2
{ - K)U'(x) + --U"{x) - \U(x) + = 0,
Zl
262 . Jeanblanc-Picque and A. N. Shiryaev

equivalent to
(2.18)

Clearly, in the investigation of the properties of U(x) we can put cr2/2 = 1 from the
very beginning, which results in replacing , , by /( 2 /2), /(2/2), /(2/2)
in the final result. The general solution of (2.18) (with 2/2 = 1) has the form

pix p x
U(x) = C i e + C2e * +^ , (2.19)

where

- fK-

are the roots of the quadratic equation

2 + {- K)p - = 0

(here pi > 0, p 2 < 0 since > 0).


From (2.7) it follows that V(x) ^ K/\ (since u(x) ^ K). Hence among the
solutions in (2.19) we should choose bounded ones, which gives C\ = 0. By the
interpretation of the problem the function V(x) should be non-decreasing in x.
Therefore, the required solution V(x) (for > ) should have the form

U(x) = ^--Bep2X, (2.19a)


where the constant (so far unknown) ^ 0.


In the domain 0 < < the required function V = V(x) satisfies (2.16) and so
it is of the form
U(x) = AieriX + A2er2X, (2.19b)
where

Since we should have U(0) = 0, from (2.19b) we find that + = 0 and so the
required solution belongs to the family

= A\e~ 2X(e
x
U(x) e~x ) ,

where A\ is a constant, = J ('2/2) + .


Putting A = 2A\ we see that

U(x) = Ae-ixsinh(Ax). (2.20)


Optimization of the flow of dividends 263

Thus we have three unknown constants A, B, and x. In addition, in the domain


< X the representation (2.20) 'acts' and in > we have (2.19a).
We shall seek the unknown constants ,, from the following supplementary
conditions at x:

U{x-) = U(x+), U'ix-) = U'{x+), U"(x-) = U"(x+). (2.21)

The first condition is simply the continuity of the function at the border and
is quite natural. The second condition is the so-called (heuristic) 'smooth gluing
condition' (in this respect see, for example, [7]). Finally, the condition that the
2
second derivative be continuous at is motivated by the requirement U S C (0, oo)
for applying Ito's formula.
We note that from (2.14) and (2.15) it is clear that the system of conditions (2.21)
is equivalent to the system

U(x-) = U(x+), U'(x-) = 1, U'(x+) = 1. (2.22)

In the domain < from (2.20) we find that

x
U'(x) = Ae~* JAcosh(Ax) - ^sinh(Az) j , (2.23)

17" (z) = Ae-*x { ( ()2 + 2 ) sinh(Aa;) - cosh(Aa;)} .

i.VV2/ / J (2.24)

By (2.19a) in > we have

U'(x) = -BP2ep2X, U"(x) = -Bp\enx. (2.25)


Hence (2.22) takes the form

lAcosh(Ax) sinh(A)| 1, (226)

- Bp2eP2X = 1.

By the last equation BeP2X I/P2- Therefore, dividing the second equation
in (2.26) by the first one we find that is a solution of

(2.27)
{ + Kp2) + 22

This equation was obtained under the assumption that 0 < < oo. We discuss the
question of when the solution of (2.29) really satisfies this condition.
To this end wefixthe values of > 0, > 0 and let - oo. Then


264 . Jeanblanc-Picque and A. N. Shiryaev

and the right-hand side of (2.27) converges to

which is greater than zero (since > 0) and less than one (since > 0).
Thus, for large equation (2.27) has a solution = {), which is in fact
unique, and
x(K) - x(oo),
where x(oo) is a solution of

tanh(Az) = 2 2 ^ , (2.28)

2
with = \]{/2) +.
On the other hand, if > oo, then

and the right-hand side of (2.27) converges to 1. Consequently, by the properties


of tanhx, equation (2.27) does not have a positive solution for small K.
Thus it becomes clear that for the existence of a solution 0 < < oo the
parameters , , should satisfy

< alVTiV, < 1- (2-29)


( + 2) + 22
For our purpose it is sufficient (with fixed > 0 and > 0) to find out for which
Kt the root of the equation (2.27) becomes zero. We can see directly from (2.27)
that the condition -I- Kp2 = 2 should hold, that is, K* should be a root of the
equation
^ = M#.)l> (2.30)
where
-

(Such a number K* exists and is unique, which follows from the properties of the
functions X/K and \p2{K)\.)
Thus if Kt, then x{Kt) = 0 and the function we seek is

U{x) = ^ - B e W .
A

Since we should have U(0) = 0, it follows that = Kt/\, and so for = *


Optimization of the flow of dividends 265

Next we how that (for = Kt) the function U(x) in fact coincides with the
function Vo(x) introduced in (2.7). Therefore (see (2.6)),

V{x)= max {Z0{x)+U(x-Z0(x))}. (2.32)

From (2.31) we deduce that in (2.32) the maximum is reached when ZQ{X) = x.
Thus if = *, then it is appropriate to pay a dividend of the size of the available
capital x. So in this case = 0, ZQ{X) = x, and Xt = 0 for t > 0.
5. And so we assume that > Kt- In this case, as was shown above, the
Stefan problem (2.16)-(2.17) with boundary conditions (at x) (2.22) (or, equiva-
lently, (2.21)) has a solution where is defined by (2.27) and

where
i Ae~2xsmh(Ax),

* Be^
x<x,

x>x ( 2
33)

\P2\
(from the third equation in (2.26)), and the constant A is obtained from either of
the first two equations in (2.26). To emphasize the dependence of U(x) on we
shall also write U(x;K).
Now we give a proof of the fact that for > K* the function U(x) from (2.33)
indeed coincides with the function V(x) defined in (2.5) and, moreover, the optimal
strategy of payment of dividends is this: Z0(x) = 0 for all ^ 0 and

fO, < x,
u{x) ~ \ r, . ~
y : > x.
Applying Ito's formula to U(x) from (2.33) we find that (cf. (2.10)) for the control
= () we have

U(x) = Exe-xitA^U(XtAT) (2.34)

- Ex / e-XsL{u)U(Xs) ds-Ex / ae^sU\X8) dWs


Jo Jo

rtAT -

X
e~XsU(Xs) ds-Ex / ae--XsXsU'
U'{Xs) dWa.
Jo Jo
Since 0 < U'(x) ^ C, the mathematical expectation of the last term in (2.34) is
zero, and going to the limit as t > oo we find that

U(x) = EX [ e-Xsu(Xs) ds.


266 . Jeanblanc-Picque and A. N. Shiryaev

Thus, given that Z0(x) = 0, we get U{x) = V(x) and the control = () is
optimal.
6. Now we consider the possibility of instantaneous payment of dividend
(Zo(ar) 0). Then by (2.6)
V(x) = max {Z0(x) + U(x-Z0(x))\. (2.35)
!()!

From the properties of U(x) it follows that if < , then U'(x) ^ 1 and U'(x) = 1.
Therefore, for < the maximum in (2.35) is reached when Zo(x) = 0 and,
consequently, instantaneous payment of dividend should not be made. However, if
> x, then U'{x) < 1 and U{x) > x. The maximum in (2.35) is reached when
ZQ (X) = and
V(x) = {x-x) + U(x). (2.36)
In other words, in the case > the dividend of should be paid at once
and the process X should then start from the state Xo = x.
Collecting all the results proved, we formulate them in the following assertion.
Theorem A. In the model A (see (1.4)) the optimal process of payment of dividend
and the function V = V(x) {see (1.2)) are described in the following way. Let > 0,
> 0.
1) // ^ *, where * is the root of equation (2.30), then having the initial
capital Xo = we pay the dividend Zo(x) = at once and Xt 0 for all t > 0.
The function V is given by V(x) = x.
2)IfK>K,, then
r , < x(K),
0[X>
\x-x(K), x^x(K),
where x{K) is the root of (2.27). The optimal function is
0, < x(K),
u(x)
V ;
=.
' , > x(K).
In addition
r (,), x<x(K),
(X)
\(x-x(K)) + U(x(K),K), x>x{K),
where
TU ,\ f Ae~$xsmh(Ax), < {),
U(x,K) = <

and the constants A, B are defined by (2.26). At x{K) we have

V(x(K)) = ^ . (2.37)

Remark 1. Assertion (2.37) follows by continuity from (2.16) taking account of


V(x) = 1 and V"(x,K) = 0 .
Remark 2. If > oo, then
x(K) - a?(oo),
where () is the root of (2.28) and U(x; K) -> V(x), where V(x) is defined below
in (4.5).
Optimization of the flow of dividends 267

3. The case
1. In this case the dividend payment moments 0 = To < T\ < ... and the amounts
paid 3o,3i, form a multivariant point process {Ti,fa)i^o- Here

Zt=Yie-XT'iiHTi^t). (3.1)

We assume that (3.1) 'acts' for t < = inf{s : Xs = 0} and

V(x) = sup Ex ^XTi (h ~ l)I{Ti < t), (3.2)

where 7 > 0 is interpreted as the transaction cost for each payment of dividend,
which corresponds to frequent 'switching' of the evolution process of the capital
X = (Xt)t^o having stochastic differential

dXt = dt + dW dZt- (3.3)

If 3~f = a(Xs,s $; t), then we assume that the moments * are Markov moments
(stopping times) with respect to (3ri>i)i>o and the random variables fa are
7. -measurable.
2. We shall find the function V(x) and the optimal strategy = (;, 3~i);jo following
the same ideas as in 2 based on 'testing properties'.
To this end we assume that a certain function V = V(x) of class C2(0,00) is
considered as a 'candidate' for V(x). Then for a strategy (with 30 = 0) and the
corresponding process X we have ( = inf{s : Xs = 0})

-(^() = V(X0) + [ (-e~Xs\V(Xs))ds (3.4)


Jo

+ / e-XsV'(Xs-)dXs +zU e~XsV"(Xs)a2ds


Jo Jo
+ e-Xs{V(Xs)-V(Xs.)-AXsV'(Xs_)}

t/\T ^ rt/\T ^

/ Xs Xs
e- LV(Xs)ds+ / ae~ V'{Xs)dWs
Jo
>
" [V(XTt) - V(XTi-)]l(Ti ^ t )
= V(X0)+ I ' e~XsLV{Xs)ds
Jo
ftAT ^
Xs x T AT
ae- V'(Xs)dWs - }2e- ^ ' >(fa - 7 )
Jo
XTi
e~ [V(XTi) - V(XTi-) - (AXT, +
268 . Jeanblanc-Picque and A. N. Shiryaev

where
LV(x) = '() + "() - XV(),

and we have used the fact that ^ = li-


From (3.4) we can see that
tAT
~ ~ ftAT ~
V[x) = Exe-^tATW(Xt^T) - Ex / e-XsLV(Xs)ds (3.5)
Jo
tf\T ^

/
ae-XsV'(Xs) dWs + Ex V e~XT' ( 3i - 7 )/( 4 < t )
e XT
- Ex ~ ' [V{XTi) - V{XTi-) - AXTi - 7] J(Ti < t ).

If we assume that the function V = V(x) satisfies (cf. (2.9))

LV{x) ^ 0, > 0, (3.6)

and
V(x)-V(y)^(x-y)-j, > y, (3.7)
then from (3.5) we find that

+ Exe-x(Ti^V(XtAT) - Ex / ae-XsV'{Xs) dWs. (3.8)

Assuming additionally that V'(x) and i^(a;) are bounded, we let t > 00 in (3.8) to
obtain
/() > , e~XT< ( - ){ < ). (3.9)

To make conditions (3.6), (3.7) more precise (they are necessary tofindV(x)
coinciding with V(x)) we refer to the following heuristic argument suggesting the
structure of the optimal strategy (,3)^-
If the initial capital X$ = is 'large', then it seems appropriate to pay a certain
dividend 30(x) at once and then to begin the observation of the evolution of X with
the initial state IQ{X). Then it is clear that as in (2.6) we have

V{x) - max {{io{x) ~ l) + V0{x - io{x))},

where V0(x) is a function coinciding with the right-hand side of (3.2) but with i ^ 1.
At the same time, the following strategy of dividend payment seems natural:
choose two thresholds a < b and when X reaches b, pay the dividend b a, that is,
Optimization of the flow of dividends 269

at the moments = infji > T,_i : Xt- = 6} we have { = a and fc = { =


b a. Then clearly VQ(X) should satisfy the following condition at a and b:

These considerations lead us to the natural idea of finding the required function
V = V(x) and the thresholds a, b as a solution of the following problem:
LV(x) = 0 , 0 < < b,
V{x)=V(a) + (x-a)-j, ^ b, (3.10)
V(0) = 0.
Using the last condition (V(Q) = 0), the solution of the equation LV(x) 0 has
the form
V(x) = -/2 sinh(Ax), 0 iC ^ b, (3.11)
with = ^ + (cf. (2.20)).
Thus we have three unknown constants: A, a, and b. Applying the concept of
'smooth gluing' to the condition V(b) = V(a) + (b a) 7, we add two more
conditions at a and b
V'(a) = 1, V'(b) = 1. (3.12)
We show that a, b, and A can now be found uniquely. Since

V(b)-V(a)= [ V'(y)dy,
the condition V(b) V(a) = (b a) 7 takes the form

1
l-b
(1-V'(y))dy = 1. (3.13)

hetip{y\A) = 1-V'(y). ThenJ a


rb
/
/ ip{y;A)dy = y {\) = 0,
Ja

To show that this problem has a solution, we observe that (cf. (2.23), (2.24))
x) - -sinh(Aa;)i,
2 J
V'(x)=AeSx
V"(x) = A
) sinh(Aa;) - cosh(Ax) | .
270 . Jeanblanc-Picque and A. N. Shiryaev

If x is a root of the equation

/
tanh(Aa;) =
(/2)2 + 2 V 2 2 -

(cf. (2.28); = ()), then V"(x) = 0 and

V'(x) = A e - ^ A c ^
-\~ fj, j2

So the function (; A) 1 - V'(x) has the properties: (; A) I -oo as A f oo


and y)(x; A) f 1 as ^4 \. 0 for each ^ 0.
Thus, beginning with large A and decreasing it, we find unique values A,a,b
with

/ <p(y;A)dy=~/, (;)=0, <^(6;)=0. (3.14)
Ja
Let V(x) be the function (3.11) with A = A. We define the strategy =
(?i,Jt)i^o in the following way:

_ \ ^ b,
3
~ \ 0 if < b,
ft = inf {t > fi-x :Xt- = b},
3i = 6 - a.

We show that for the strategy we have constructed the corresponding value

" A f (34 - 7 ) ( ; < r)

exactly coincides with the function V(x) found, and moreover, V(x) = V(x), that
is, is optimal.
To prove V(x) = V(x; ) we use Ito's formula (3.5), taking the process X defined
by the strategy and assuming that < b.
Since LV(x) = 0, in (3.5) we have

Ex / e~XsLV(Xs)ds = 0.
Jo

The mathematical expectation of the stochastic integral vanishes,

E^ / e~XsV'(Xs)dWs = 0 ,
Jo
Optimization of the flow of dividends 271

since the derivative V'(x) is bounded. Next, for , ^ r

V(XTi) - V{XTi.) - AXTi - 7 = V(a) - V(6) - (5 - 6) - 7 = 0

by the construction of and b.


So, for each t > 0

*S t ).

Passing to the limit as t > 00 we find the required equality

V(x)=V(x;n), < b.

Now let x ^ b . T h e n by (3.10),

V(x) = V(a) + (x - a) - 7.

At the same time, by the definition of the strategy = (Ti^i^o, for ^ b we


have _
V(x; ) = V(a; ) + (x -a) 7.
But V{a) = V(Z; ). Therefore, V(x) = V{x; ) for all ^ b.
It remains to show that for any strategy

V(x)2V(x;n).
We showed above that for this it is sufficient to verify that

LV(x) ^ 0, > 0, (3.15)


and
(x - y) - 7, x>l- (3.16)
In the domain < b we have LV(x) = 0. In the domain ^ b

V(x) = V(S) + (x - a) - 7

and

^ ; -X[V(a) + {b-a) -7] + = -^(6)+/ = 0,

since by continuity from LV(x) = 0, a; < b, we obtain L"K(&) = 0.


Thus, (3.15) has been established.
Finally, (3.16) is equivalent to the inequality

which is obviously satisfied by the properties of (;) = 1 V'(u) and the way
the constant A was defined in the process of solving (3.14).
We formulate the results obtained in the following assertion.
272 . Jeanblanc-Picque and A. N. Shiryaev

Theorem B. In the model (see (1.5)) the optimal dividend payment strategy
and the function V = V(x) (see (3.2)) are described in the following way.
Let > 0 , > 0, 7 > 0 and suppose that the constants A, a, and b are defined
by solving (3.14).
1) If ^ b, then we make an instantaneous payment of the dividend 30 = b a
and the evolution of the capital starts with the value a.
2) If < b, then TQ = 0, 30 = 0 and the payment of the dividend is made when
the process X reaches the threshold b with instantaneous payment of dividend
of size b a, that is,

% = inf {* > T t _! : Xt_ = 6}, ~h = b-a.

Remark 1. By (3.11) the problem (3.14) takes the following form:

A[e-$lsmh(Ab) - e-^sinh(Aa)] =(6-5) - 7 ,

o)-|sinh(A5)^ = l,

Ae-7b\Acosh(Ab) - ^si
) ='
where =
Remark 2. As 7 -* 0,
> , b t x,

where is a solution of

tanh(Ax) =
(/2) 2 2A2-XJ'
Remark 3. The following figure shows the behaviour of the function

' Ae~2xsinh(Ax), 0 ^ < 6,


V(x) = a
(x - a) - 7 + Ae~2 sinh(Aa), > b.

v(x).

v'(B)=\

a
Optimization of the flow of dividends 273

4. The case C
1. We proceed to the general case where the (admissible) process of dividend
payment {Zf)t^o is an arbitrary non-decreasing right-continuous (for t > 0)
process. We assume that Zt is $ = a(Ws,s $J immeasurable for each t > 0.
Moreover, we assume that Zn = ZQ(X) is a measurable function with ZQ(0) = 0 and
Z0(x) sC x.
In this situation we take a process X = (Xt)t^o satisfying

X0 = x, X0+=x-Z0(x), (4.1)

and for t > 0


Xt = (:c - Zo(a:)) + + aWt - (Zt - Zo+). (4.2)
From heuristic considerations we can expect that the optimal process
(Zf)t:>o on which
( r ~\
e-xtdZt\ (4.3)
(0,oo) J

is reached can be obtained by the limit passage in the cases A and as > oo
and 7 0, respectively.
To this end we note that in the case A the optimal threshold x(K) converges to
i(oo), which is a solution of the equation

tanh(A.) = ^ - -

with = (/2) 2 + .
In the case the quantities a and b get closer as 7 > 0, converging to = ()
(see Remark 2 in 3).
All this suggests that in the general case we can expect the structure of the
optimal process = (Zt)t^o of dividend payment to be such that when i > i w e
need to pay at once the dividend and then 'run' the process X from x, where
we place a reflecting barrier (since as 7 00 the quantities a and b converge to
each other). Here the accumulation of dividends will take place in local time given
by the visits of X at the reflecting barrier x.
2. This heuristic argument can be justified in the following way. Let be the root
of the equation

tanh(As) = ^ -, (4.4)

_ r ~Ae-'ix sinh(Ax), 0 ^ ^ x,
V(x) = \ _ _ _ (4-5)
{ (x x) + V(x), > x,
where A is such that
274 . Jeanblanc-Picque and A. N. Shiryaev

Prom the considerations of 2, 3 it follows that


2

-XV () + '() + %-V"{x) = 0, < x,

F(0) = 0, V'(x) = 1, V"(x) = 0.


2
Clearly, V C (0,oo).
Let < x. Consider the solution (X,L) = (Xt,Lt)t^o of the stochastic differ-
ential equation with reflection (see [4], Ch. IX, 2, Exercise 2.14)

where L = (Lt)t^o is a continuous non-decreasing iF^-adapted process with LQ = 0


such that
Lt=
I{Xs=x)dLs. (4.8)
Jo
It is well known that a solution (X,L) exists, is the reflecting barrier for X, and
L is a local time determined by the process X at the boundary x.
We show that for ^

e~xtdLt = V{x), (4.9)

where = inf{i ^ 0 : Xt = 0} and the function F(a;) is defined by (4.5).


As in 2, 3, we apply Ito's formula to the semimartingale X (see [3]):

e~xi-tAT)V(XtAr) = V(x) + / (-Xe-XsV(Xs)) ds


Jo
- pt/\T
+ V'(Xs)e-XsdXs +- a2e-XsV"(Xs)ds. (4.10)
Jo * Jo
Taking (4.7) into account we get

( 7 T
V(x) = - - () - / LV(XS) ds
Jo
rtAT r-tAT
+ e-XsV'(X8)dLs- ae-XsV'(Xs)dWs, (4.11)
Jo Jo
where
_
LV = -AK + /iT + y.

By the definition of V = V{x) and by the properties of (X, L)

As
Ex / LV(XS) ds = 0, Ex / e- F ( X s ) dWs = 0.
Jo Jo
Optimization of the flow of dividends 275

Therefore, taking account of V (x) = 1, we obtain the required equality (4.9) by


letting t > oo in (4.11).
Now, let > x. Then we put ZQ{X) = and

~Zt = ~Z~n(x)I(x > x) + L* (4 12)


Clearly, for such a process of dividend payment we have
(T ( fT \
s
E l e~^ rl7 / r -L F / ~^s >, ^"\
Jo \ Jo S
+ EX [ e~ A s dLs I(x ^x) = V(x), (4.13)
Jo
where V(x) is defined by(4.5).
3. Now we show that for any admissible dividend payment process = {Zt)t^o

V(x;Z)^V(x), (4.14)
where V{x; Z) = Ex /QT e~Xs dZs, = inf{t : Xt = 0} and

/ e " A s dZs = Z0(x) + . e " A s dZs.


O J(0,T)

xt
Let X be the process corresponding to Z. Applying Ito's formula to e V(Xt)
we get
rtAT
e'x(tAT)V{XtAr) = V{x) + / (-Xe~XsV{Xs))ds
Jo
+ / e-XsV'{Xs^)dXs +- / a2e~XsV"(Xs)ds
Jo * Jo
+ e-Xs{V(Xs)~V(Xs^)-V'(Xs_)AXs}
rt/\T rtAT
= V(x) - / e-XsV'(Xs-) dZs + / e-XsLV(Xs) ds
Jo Jo
rtAT
Xs
+ / ae- V'{Xs)dWs
Jo

+ e-Xs{V(Xs)~V(X^)-V'(Xs^)AXs}.

Hence it follows that


ft/\T rtAT
V(x)= e~XsdZs- e~Xs(l-V'(Xs-))dZs (4.15)
Jo Jo rtAr
- /rtAr e-XsLV{Xs)ds- /tA ae-XsV'(Xs)dWs
Jo Jor
276 . Jeanblanc-Picque and A. N. Shiryaev

Since V'{x) > 1,


/
As
2 = - e " ( l - V'(X.-)) dZs > 0.
Jo
For < we have LV{x) 0, and for ^

- L F ( x ) = AF(x) - ^ AF(x) - = -LV(x) = 0.

Therefore,
/

3
Jo
< , then

F(/3) - F ( a ) - '()( -a)= (V'(y) - F'(/3)) cfy > 0,

since V (y) is decreasing. Therefore,

Since the derivative V (x) is bounded,


/-

e-XsV'(Xs)dWs = 0.
o
Next,
hm E , e - A ( i A r ) F ( X t A r ) = 1.

Therefore, taking in (4.15) the mathematical expectation E x and letting t -t oo,


we obtain
V(x) ^ Ex [ e-XsdZs = V(x;Z).
Jo
Thus the following assertion has been proved.
Theorem C. In the model C the optimal strategy of dividend payment is described
in the following way. Let > 0, > 0 and let be the root of the equation

tanh(Ax) = i= -, w/iere =W ( ^ ) + A.

1) If > x, then we make an instantaneous payment of dividend equal to ,


that is, Zo(x) x.
2) If = x, then the dividend payment process L (Lt)t^o and the corresponding
process X (Xt)t^o of capital evolution are solutions of a stochastic
differential equation with reflection (4.7)-(4.8). In addition, the function
V = V(x) of optimal payment of dividends is given by (4.5).
Optimization of the flow of dividends 277

Bibliography
[1] R. Radner and L. Shepp, Risk vs. profit-potential; a model for corporate strategy (to appear).
[2] R. Radner and L. Shepp, Risk vs. profit-potential; a model for corporate strategy, Preprint.
[3] J. Jacod and A. N. Shiryaev, Limit theorems for stochastic processes, Springer-Verlag,
Berlin 1987.
[4] D. Revuz and M. Yor, Continuous martingales and Brownian motion, Springer-Verlag,
Berlin 1991.
[5] M. Jeanblanc-Picque, "Impulse control method and exchange rate", Math. Finance 3:3
(1993), 161-177.
[6] A. K. Zvonkin, "A transformation of the phase space of a diffusion process that will remove
the drift", Mat. Sb. 93 (1974), 129-149; English transl. in Math. USSR-Sb. 22 (1974).
[7] L. E. Dubins, L. A. Shepp, and A. N. Shiryaev, "Optimal stopping rules and maximal
inequalities for Bessel processes", Teor. Veroyatnost. i Primenen. 38 (1993), 288-330; English
transl. in Theory Probab. Appl. 38 (1993).

Steklov Institute of Mathematics,


Russian Academy of Sciences
Received 26/OCT/94
Translated by M. CAPINSKI

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