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Dependence of the Optimal Risk Control Decisions on the Terminal Value for a Financial Corporation

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  • Michael Taksar

Abstract

The paper deals with the model of a firm which has a possibility to choose among a variety of production/business policies with different risk and profit potential. The objective is to find the policy which maximizes the expected total discounted dividend pay-out until the time of bankruptcy. The bankruptcy is defined as the time when the liquid assets of the company vanish. A typical example of such a corporation would be an insurance company whose different business activities correspond to choosing different levels of reinsurance. The main novelty of this model is in introduction of terminal value of the company at the time of the bankruptcy. This could be the value of non liquid assets (such as real estate or the rights to conduct business or the trade name), which at the time of bankruptcy are subject to sale with proceeds distributed among shareholders. We model the dynamics of the corporate liquid assets as a diffusion process with controllable drift and diffusion coefficients. Diffusion coefficient corresponds to risk, while drift represents potential profit. In our model the potential profit proportional to the risk. The dividend distribution is modeled by an increasing functional, which is also controllable. We show how to obtain solution for this problem starting with the solution to the problem with zero terminal value. Copyright Kluwer Academic Publishers 2000

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  • Michael Taksar, 2000. "Dependence of the Optimal Risk Control Decisions on the Terminal Value for a Financial Corporation," Annals of Operations Research, Springer, vol. 98(1), pages 89-99, December.
    • Handle: RePEc:spr:annopr:v:98:y:2000:i:1:p:89-99:10.1023/a:1019239920624
    DOI: 10.1023/A:1019239920624
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    Cited by:

    1. Peng, Xiaofan & Chen, Mi & Guo, Junyi, 2012. "Optimal dividend and equity issuance problem with proportional and fixed transaction costs," Insurance: Mathematics and Economics, Elsevier, vol. 51(3), pages 576-585.
    2. Igor G. Pospelov & Stanislav A. Radionov, 2015. "Optimal Dividend Policy When Cash Surplus Follows The Telegraph Process," HSE Working papers WP BRP 48/FE/2015, National Research University Higher School of Economics.
    3. Guan, Huiqi & Liang, Zongxia, 2014. "Viscosity solution and impulse control of the diffusion model with reinsurance and fixed transaction costs," Insurance: Mathematics and Economics, Elsevier, vol. 54(C), pages 109-122.
    4. Cheng, Gongpin & Zhao, Yongxia, 2016. "Optimal risk and dividend strategies with transaction costs and terminal value," Economic Modelling, Elsevier, vol. 54(C), pages 522-536.
    5. Taksar, Michael & Hunderup, Christine Loft, 2007. "The influence of bankruptcy value on optimal risk control for diffusion models with proportional reinsurance," Insurance: Mathematics and Economics, Elsevier, vol. 40(2), pages 311-321, March.
    6. Yao, Dingjun & Yang, Hailiang & Wang, Rongming, 2014. "Optimal risk and dividend control problem with fixed costs and salvage value: Variance premium principle," Economic Modelling, Elsevier, vol. 37(C), pages 53-64.

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