Finite Time Dividend-Ruin Models
25 Pages Posted: 22 Feb 2007
Date Written: February 2007
We consider the finite time horizon dividend-ruin model where the firm pays out dividends to its shareholders according to a dividend-barrier strategy and becomes ruined when the firm asset value falls below the default threshold. The asset value process is modeled as a restricted Geometric Brownian process with an upper reflecting (dividend) barrier and a lower absorbing (ruin) barrier. Analytic solutions to the value function of the restricted asset value process are provided. We also solve for the survival probability and the expected present value of future dividend payouts over a given time horizon. The sensitivities of the firm asset value and dividend payouts to the dividend barrier, volatility of the firm asset value and firm's credit quality are also examined.
Keywords: dividend-ruin model, dividend payouts, reflecting and absorbing barriers
JEL Classification: G31
Suggested Citation: Suggested Citation
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By Jinxia Zhu