Optimization of capital injections and absolutely continuous dividend payments in a diffusion model

Abstract

We investigate a joint optimization problem of dividend payments and capital injections for a surplus process driven by a general diffusion. Dividend payments are assumed to be absolutely continuous in time, with the dividend rate bounded by a nonnegative concave function of the current surplus; while capital injections are modelled by a general nondecreasing process. We first analyze an auxiliary bail-out problem in which capital injections are required to keep the surplus nonnegative at all times. Under a concavity assumption on the drift, we prove that the associated value function is concave and is a classical solution of the corresponding Hamilton-Jacobi-Bellman (HJB) equation. We further characterize an optimal policy as a refraction-reflection strategy: the surplus is reflected at zero by capital injections, while dividends are paid at the maximal admissible rate whenever the surplus exceeds an optimal threshold. Our main contribution establishes that the general optimization problem exhibits a Lokka-Zervos type dichotomy. More precisely, an optimal policy is either a dividend refraction strategy without injections, in which ruin occurs, or a refraction-reflection dividend-injection strategy. This optimal injection decision is characterized through a simple comparison of the auxiliary value functions at the origin.