The Riccati equation in mathematical finance

Abstract

This paper uses ideas from symbolic computation to classify solutions to an important class of problems in mathematical finance and thus provides a linkage between these two fields. We show that Kovacic's concept of closed-form solutions to the Riccati ordinary differential equation can be used to provide a precise mathematical definition that is useful in certain financial models. We extend this definition to a broader class of problems and discuss how these ideas can be usefully applied to practical problems in the finance area. We provide a specific application by developing a new implementation of the Cox-Ingersoll-Ross interest-rate model that may be of practical interest. © 2002 Elsevier Science Ltd.