Numerical Methods in Computational Finance. Daniel J. Duffy
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Roughly speaking, this lemma states that you cannot get a negative solution from positive input.
You can verify it by examining Equation (2.2) because all terms are positive.
The following result gives bounds on the growth of
Theorem 2.1 Let
This result states that the value of the solution is bounded by the input data. In other words, it is a well-posed problem.
We wish to replicate these properties in our difference schemes for Equation (2.1).
For completeness, we show the steps to be executed in order to produce the result in Equation (2.2).
(2.3)
Then from Equation (2.1) we see:
or:
Integrating this equation between
This style of mathematical analysis will be used in other contexts in this book, for example when transforming convection-diffusion-reaction equations (in particular, the Black–Scholes equation) to adjoint form.
2.2.2 Rationale and Generalisations
The IVP Equation (2.1) is a model for all the linear time-dependent differential equations that we encounter in this book. We no longer think in terms of scalar problems in which the functions in Equation (2.1) are scalar-valued, but we can view an ODE at different levels of abstraction. To this end, we focus on the generic homogeneous ODE with solution
This equation subsumes several special cases:
1 The variable is a square matrix, and then Equation (2.4) represents a system of ODEs. This is a very important area of research having many applications in science, engineering, and finance.
2 The variable is an ordinary or partial differential operator, and then Equation (2.4) represents an ODE in a Hilbert or Banach space.
3 The variable is a tridiagonal or block tridiagonal matrix that originates from a semi-discretisation in space of a time-dependent partial differential equation (PDE) using the Method of Lines (MOL) as discussed in Chapter 20.
4 The formal solution of (2.4) is:(2.5) In other words, we express the solution in terms of the exponential function of a matrix or of a differential operator. In the former case, there are many ways to compute the exponential of a matrix (see Moler and Van Loan (2003)).
5 The solution of Equation (2.4) can be simplified by matrix or operator splitting of the operator :(2.6) For example, we can split a matrix into two simpler matrices, or we can split an operator into its convection and diffusion components. In other words, we solve Equation (2.4) as a sequence of simpler problems in (2.6). These topics will be discussed in Chapters 18,