Matrix-based numerical modelling of financial differential equations (Q2655890)

Summary: Differentiation matrices provide a compact and unified formulation for a variety of differential equation discretization and time stepping algorithms. This paper illustrates their use for solving three differential equations of finance: the classic Black-Scholes equation (linear initial-boundary value problem), American option pricing problem (linear complementarity problem), and an optimal maintenance and shutdown model (non-linear boundary value problem with free boundary). We present numerical results that show the advantage of an L-stable time-stepping method over the Crank-Nicolson method, and results that show how spectral collocation methods are superior for boundary value problems with smooth solutions, while finite difference methods are superior for option-pricing problems.