Dependence of the optimal risk control decisions on the terminal value for a financial corporation (Q5933811)

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 the introduction of the 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. The dynamics of the corporate liquid assets are modified as a diffusion process with controllable drift and diffusion coefficients. The diffusion coefficient corresponds to risk, while the drift represents the potential profit. In the considered model the potential profit is proportional to the risk. The dividend distribution is modeled by an increasing functional, which is also controllable. It is shown how to obtain a solution for this problem starting with the solution of the problem with zero terminal value.