Singular Control in a Cash Management Model with Ambiguity

Abstract

We consider a singular control model of cash reserve management, driven by a diffusion under ambiguity. The manager is assumed to have maxmin preferences over a set of priors characterized by $\hat{I}º$-ignorance. A verification theorem is established to determine the firm's cost function and the optimal cash policy; the latter taking the form of a control barrier policy. In a model driven by arithmetic Brownian motion, we use Dynkin games to show that an increase in ambiguity leads to higher expected costs under the worst-case prior and a narrower inaction region. The latter effect can be used to provide an ambiguity-driven explanation for observed cash management behavior. Our findings can be applied to broader applications of singular control in managing inventories under ambiguity.