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doi: 10.3934/jimo.2021003
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Optimal investment and reinsurance to minimize the probability of drawdown with borrowing costs

Yu Yuan , Zhibin Liang , and  Xia Han

School of Mathematical Sciences and Institute of Finance and Statistics, Nanjing Normal University, Jiangsu 210023, China

* Corresponding author: Zhibin Liang

Received  January 2020 Revised  September 2020 Early access December 2020

Fund Project: This research was supported by the National Natural Science Foundation of China (Grant No.12071224)

We study the optimal investment and reinsurance problem in a risk model with two dependent classes of insurance businesses, where the two claim number processes are correlated through a common shock component and the borrowing rate is higher than the lending rate. The objective is to minimize the probability of drawdown, namely, the probability that the value of the wealth process reaches some fixed proportion of its maximum value to date. By the method of stochastic control theory and the corresponding Hamilton-Jacobi-Bellman equation, we investigate the optimization problem in two different cases and divide the whole region into four subregions. The explicit expressions for the optimal investment/reinsurance strategies and the minimum probability of drawdown are derived. We find that when wealth is at a relatively low level (below the borrowing level), it is optimal to borrow money to invest in the risky asset; when wealth is at a relatively high level (above the saving level), it is optimal to save more money; while between them, the insurer is willing to invest all the wealth in the risky asset. In the end, some comparisons are presented to show the impact of higher borrowing rate and risky investment on the optimal results.

Keywords: Optimal investment, proportional reinsurance, common shock dependence, borrowing constraint, stochastic optimal control, probability of drawdown.
Mathematics Subject Classification: Primary: 93E20; Secondary: 62P05, 91G05, 91G10.
Citation: Yu Yuan, Zhibin Liang, Xia Han. Optimal investment and reinsurance to minimize the probability of drawdown with borrowing costs. Journal of Industrial & Management Optimization, doi: 10.3934/jimo.2021003
References:
[1]

B. Angoshtari, E. Bayraktar and V. R. Young, Optimal investment to minimize the probability of drawdown, Stochastics, 88 (2016), 946-958.  doi: 10.1080/17442508.2016.1155590.  Google Scholar

[2]

B. Angoshtari, E. Bayraktar and V. R. Young, Minimizing the probability of lifetime drawdown under constant consumption, Insurance: Mathematics and Economics, 69 (2016), 210-223.  doi: 10.1016/j.insmatheco.2016.05.007.  Google Scholar

[3]

N. B$\ddot{a}$uerle, Benchmark and mean-variance problems for insurers, Mathematical Methods of Operations Research, 62 (2005), 159-165.  doi: 10.1007/s00186-005-0446-1.  Google Scholar

[4]

E. Bayraktar and V. R. Young, Minimizing the probability of lifetime ruin under borrowing constraints, Insurance: Mathematics and Economics, 41 (2007), 196-221.  doi: 10.1016/j.insmatheco.2006.10.015.  Google Scholar

[5]

E. Bayraktar and V. R. Young, Minimizing the probability of ruin when consumption is ratcheted, North American Actuarial Journal, 12 (2008), 428-442.  doi: 10.1080/10920277.2008.10597535.  Google Scholar

[6]

L. Bo and A. Capponi, Optimal credit investment with borrowing costs, Mathematics of Operations Research, 42 (2017), 546-575. doi: 10.1287/moor.2016.0818.  Google Scholar

[7]

S. Brown, Optimal investment policies for a firm with a random risk process: Exponential utility and minimizing the probaiblity of ruin, Mathematics of Operations Research, 20 (1995), 937-958.  doi: 10.1287/moor.20.4.937.  Google Scholar

[8]

X. Chen, D. Landriault, B. Li and D. Li, On minimizing drawdown risks of lifetime investments, Insurance: Mathematics and Economics, 65 (2015), 46-54.  doi: 10.1016/j.insmatheco.2015.08.007.  Google Scholar

[9]

J. Cvitanić and I. Karatzas, On portfolio optimization under drawdown constrainsts, IMA Volumes in Mathematics and its Applications, 65 (1995), 77-88.   Google Scholar

[10]

C. Deng, X. Zeng and H. Zhu, Non-zero-sum stochastic differential reinsurance and investment games with default risk, European Journal of Operational Research, 264 (2018), 1144-1158.  doi: 10.1016/j.ejor.2017.06.065.  Google Scholar

[11]

R. Elie and N. Touzi, Optimal lifetime consumption and investment under a drawdown constrainst, Finance and Stochastics, 12 (2008), 299-330.  doi: 10.1007/s00780-008-0066-8.  Google Scholar

[12]

C. Fu, A. Lari-Lavassani and X. Li, Dynamic mean-variance portfolio selection with borrowing constraint, European Journal of Operational Research, 200 (2010), 312-319.  doi: 10.1016/j.ejor.2009.01.005.  Google Scholar

[13]

J. Grandell, A class of approximations of ruin probabilities, Scandinavian Actuarial Journal, 1977 (1977), 37-52.  doi: 10.1080/03461238.1977.10405071.  Google Scholar

[14]

J. Grandell, Aspects of Risk Theory, Springer-Verlag, New York, 1991. doi: 10.1007/978-1-4613-9058-9.  Google Scholar

[15]

S. Grossman and Z. Zhou, Optimal investment strategies for controlling drawdowns, Mathematical Finance, 3 (1993), 241-276.  doi: 10.1111/j.1467-9965.1993.tb00044.x.  Google Scholar

[16]

X. Han, Z. Liang and K. C. Yuen, Optimal proportional reinsurance to minimize the probability of drawdown under thinning-dependence structure, Scandinavian Actuarial Journal, 2018 (2018), 863-889.  doi: 10.1080/03461238.2018.1469098.  Google Scholar

[17]

X. Han, Z. Liang and V. R. Young, Optimal reinsurance to minimize the probability of drawdown under the mean-variance premium principle, Scandinavian Actuarial Journal, 2020 (2020), 879-903.  doi: 10.1080/03461238.2020.1788136.  Google Scholar

[18]

X. Han, Z. Liang and C. Zhang, Optimal proportional reinsurance with common shock dependence to minimise the probability of drawdown, Annals of Actuarial Science, 13 (2019), 268-294.  doi: 10.1017/S1748499518000210.  Google Scholar

[19]

C. Hipp and M. Taksar, Optimal non-proportional reinsurance, Insurance: Mathematics and Economics, 47 (2010), 246-254.  doi: 10.1016/j.insmatheco.2010.04.001.  Google Scholar

[20]

X. Liang, Z. Liang and V. R. Young, Optimal reinsurance under the mean-variance premium principle to minimize the probability of ruin, Insurance: Mathematics and Economics, 92 (2020), 128-146.  doi: 10.1016/j.insmatheco.2020.03.008.  Google Scholar

[21]

X. Liang and V. R. Young, Minimizing the probability of ruin: Optimal per-loss reinsurance, Insurance: Mathematics and Economics, 82 (2018), 181-190.  doi: 10.1016/j.insmatheco.2018.07.005.  Google Scholar

[22]

Z. Liang and E. Bayraktar, Optimal proportional reinsurance and investment with unobservable claim size and intensity, Insurance: Mathematics and Economics, 55 (2014), 156-166.  doi: 10.1016/j.insmatheco.2014.01.011.  Google Scholar

[23]

Z. Liang and K. C. Yuen, Optimal dynamic reinsurance with dependent risks: variance premium principle, Scandinavian Actuarial Journal, 2016 (2016), 18-36.  doi: 10.1080/03461238.2014.892899.  Google Scholar

[24]

S. Luo, Ruin minimization for insurers with borrowing constrainsts, North American Actuarial Journal, 12 (2008), 143-174.  doi: 10.1080/10920277.2008.10597508.  Google Scholar

[25]

R. C. Merton, Lifetime portfolio selection under uncertainty: The continuous-time case, The Review of Economics and Statistics, 51 (1969), 247-257.  doi: 10.2307/1926560.  Google Scholar

[26]

R. C. Merton, Optimum consumption and portfolio rules in a continuous-time model, J. Econom. Theory, 3 (1971), 373-413.  doi: 10.1016/0022-0531(71)90038-X.  Google Scholar

[27]

S. D. Promislow and V. R. Young, Minimizing the probability of ruin when claims follow Brownian motion with drift, North American Actuarial Journal, 9 (2005), 110-128.  doi: 10.1080/10920277.2005.10596214.  Google Scholar

[28]

V. R. Young, Optimal investmet strategy to minimize the probability of lifetime ruin, North American Actuarial Journal, 8 (2004), 105-126.  doi: 10.1080/10920277.2004.10596174.  Google Scholar

[29]

K. C. Yuen, Z. Liang and M. Zhou, Optimal proportional reinsurance with common shock dependence, Insurance: Mathematic and Economics, 64 (2015), 1-13.  doi: 10.1016/j.insmatheco.2015.04.009.  Google Scholar

[30]

X. Zhang, H. Meng and Y. Zeng, Optimal investment and reinsurance strategies for insurers with generalized mean-variance premium principle and no-short selling, Insurance: Mathematic and Economics, 67 (2016), 125-132.  doi: 10.1016/j.insmatheco.2016.01.001.  Google Scholar

show all references

References:
[1]

B. Angoshtari, E. Bayraktar and V. R. Young, Optimal investment to minimize the probability of drawdown, Stochastics, 88 (2016), 946-958.  doi: 10.1080/17442508.2016.1155590.  Google Scholar

[2]

B. Angoshtari, E. Bayraktar and V. R. Young, Minimizing the probability of lifetime drawdown under constant consumption, Insurance: Mathematics and Economics, 69 (2016), 210-223.  doi: 10.1016/j.insmatheco.2016.05.007.  Google Scholar

[3]

N. B$\ddot{a}$uerle, Benchmark and mean-variance problems for insurers, Mathematical Methods of Operations Research, 62 (2005), 159-165.  doi: 10.1007/s00186-005-0446-1.  Google Scholar

[4]

E. Bayraktar and V. R. Young, Minimizing the probability of lifetime ruin under borrowing constraints, Insurance: Mathematics and Economics, 41 (2007), 196-221.  doi: 10.1016/j.insmatheco.2006.10.015.  Google Scholar

[5]

E. Bayraktar and V. R. Young, Minimizing the probability of ruin when consumption is ratcheted, North American Actuarial Journal, 12 (2008), 428-442.  doi: 10.1080/10920277.2008.10597535.  Google Scholar

[6]

L. Bo and A. Capponi, Optimal credit investment with borrowing costs, Mathematics of Operations Research, 42 (2017), 546-575. doi: 10.1287/moor.2016.0818.  Google Scholar

[7]

S. Brown, Optimal investment policies for a firm with a random risk process: Exponential utility and minimizing the probaiblity of ruin, Mathematics of Operations Research, 20 (1995), 937-958.  doi: 10.1287/moor.20.4.937.  Google Scholar

[8]

X. Chen, D. Landriault, B. Li and D. Li, On minimizing drawdown risks of lifetime investments, Insurance: Mathematics and Economics, 65 (2015), 46-54.  doi: 10.1016/j.insmatheco.2015.08.007.  Google Scholar

[9]

J. Cvitanić and I. Karatzas, On portfolio optimization under drawdown constrainsts, IMA Volumes in Mathematics and its Applications, 65 (1995), 77-88.   Google Scholar

[10]

C. Deng, X. Zeng and H. Zhu, Non-zero-sum stochastic differential reinsurance and investment games with default risk, European Journal of Operational Research, 264 (2018), 1144-1158.  doi: 10.1016/j.ejor.2017.06.065.  Google Scholar

[11]

R. Elie and N. Touzi, Optimal lifetime consumption and investment under a drawdown constrainst, Finance and Stochastics, 12 (2008), 299-330.  doi: 10.1007/s00780-008-0066-8.  Google Scholar

[12]

C. Fu, A. Lari-Lavassani and X. Li, Dynamic mean-variance portfolio selection with borrowing constraint, European Journal of Operational Research, 200 (2010), 312-319.  doi: 10.1016/j.ejor.2009.01.005.  Google Scholar

[13]

J. Grandell, A class of approximations of ruin probabilities, Scandinavian Actuarial Journal, 1977 (1977), 37-52.  doi: 10.1080/03461238.1977.10405071.  Google Scholar

[14]

J. Grandell, Aspects of Risk Theory, Springer-Verlag, New York, 1991. doi: 10.1007/978-1-4613-9058-9.  Google Scholar

[15]

S. Grossman and Z. Zhou, Optimal investment strategies for controlling drawdowns, Mathematical Finance, 3 (1993), 241-276.  doi: 10.1111/j.1467-9965.1993.tb00044.x.  Google Scholar

[16]

X. Han, Z. Liang and K. C. Yuen, Optimal proportional reinsurance to minimize the probability of drawdown under thinning-dependence structure, Scandinavian Actuarial Journal, 2018 (2018), 863-889.  doi: 10.1080/03461238.2018.1469098.  Google Scholar

[17]

X. Han, Z. Liang and V. R. Young, Optimal reinsurance to minimize the probability of drawdown under the mean-variance premium principle, Scandinavian Actuarial Journal, 2020 (2020), 879-903.  doi: 10.1080/03461238.2020.1788136.  Google Scholar

[18]

X. Han, Z. Liang and C. Zhang, Optimal proportional reinsurance with common shock dependence to minimise the probability of drawdown, Annals of Actuarial Science, 13 (2019), 268-294.  doi: 10.1017/S1748499518000210.  Google Scholar

[19]

C. Hipp and M. Taksar, Optimal non-proportional reinsurance, Insurance: Mathematics and Economics, 47 (2010), 246-254.  doi: 10.1016/j.insmatheco.2010.04.001.  Google Scholar

[20]

X. Liang, Z. Liang and V. R. Young, Optimal reinsurance under the mean-variance premium principle to minimize the probability of ruin, Insurance: Mathematics and Economics, 92 (2020), 128-146.  doi: 10.1016/j.insmatheco.2020.03.008.  Google Scholar

[21]

X. Liang and V. R. Young, Minimizing the probability of ruin: Optimal per-loss reinsurance, Insurance: Mathematics and Economics, 82 (2018), 181-190.  doi: 10.1016/j.insmatheco.2018.07.005.  Google Scholar

[22]

Z. Liang and E. Bayraktar, Optimal proportional reinsurance and investment with unobservable claim size and intensity, Insurance: Mathematics and Economics, 55 (2014), 156-166.  doi: 10.1016/j.insmatheco.2014.01.011.  Google Scholar

[23]

Z. Liang and K. C. Yuen, Optimal dynamic reinsurance with dependent risks: variance premium principle, Scandinavian Actuarial Journal, 2016 (2016), 18-36.  doi: 10.1080/03461238.2014.892899.  Google Scholar

[24]

S. Luo, Ruin minimization for insurers with borrowing constrainsts, North American Actuarial Journal, 12 (2008), 143-174.  doi: 10.1080/10920277.2008.10597508.  Google Scholar

[25]

R. C. Merton, Lifetime portfolio selection under uncertainty: The continuous-time case, The Review of Economics and Statistics, 51 (1969), 247-257.  doi: 10.2307/1926560.  Google Scholar

[26]

R. C. Merton, Optimum consumption and portfolio rules in a continuous-time model, J. Econom. Theory, 3 (1971), 373-413.  doi: 10.1016/0022-0531(71)90038-X.  Google Scholar

[27]

S. D. Promislow and V. R. Young, Minimizing the probability of ruin when claims follow Brownian motion with drift, North American Actuarial Journal, 9 (2005), 110-128.  doi: 10.1080/10920277.2005.10596214.  Google Scholar

[28]

V. R. Young, Optimal investmet strategy to minimize the probability of lifetime ruin, North American Actuarial Journal, 8 (2004), 105-126.  doi: 10.1080/10920277.2004.10596174.  Google Scholar

[29]

K. C. Yuen, Z. Liang and M. Zhou, Optimal proportional reinsurance with common shock dependence, Insurance: Mathematic and Economics, 64 (2015), 1-13.  doi: 10.1016/j.insmatheco.2015.04.009.  Google Scholar

[30]

X. Zhang, H. Meng and Y. Zeng, Optimal investment and reinsurance strategies for insurers with generalized mean-variance premium principle and no-short selling, Insurance: Mathematic and Economics, 67 (2016), 125-132.  doi: 10.1016/j.insmatheco.2016.01.001.  Google Scholar

Figure 1.  The influence of higher borrowing rate on the optimal investment strategies
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Figure 2.  The influence of higher borrowing rate on the optimal reinsurance strategies
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Figure 3.  The influence of risky investment on the optimal reinsurance strategies
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