Classical Solutions for a Finite-Horizon Exit-Time Problem with Degenerate Diffusion Control

Abstract

We study finite-horizon exit-time control of a one-dimensional affine diffusion, with an unbounded control acting on both drift and volatility. Since an admissible control can cancel the instantaneous volatility, the associated HJB equation is not uniformly parabolic. Moreover, the location of the degeneracy is not prescribed by the model coefficients but depends on the unknown value function and optimal feedback. Rather than relying on a viscosity-solution formulation, we work under suitable structural assumptions and prove that the value function is a $C^{1,2}$ classical solution throughout the interior of the state domain and is strictly convex in the state variable. Moreover, we construct a locally Lipschitz optimal feedback, explicitly identify the degenerate set as a curve, and show that the closed-loop drift on this curve equals the time derivative of its state coordinate. Finally, we prove invariance and inaccessibility before exit and derive exact squared-logarithmic asymptotics for approach probabilities.