Portfolio Optimization

and Stochastic Control.

Closed-Form Solutions to the
HJB Equation through Lie Symmetries.

Solomon M. Antoniou
SKEMSYS
Scientific Knowledge Engineering
and Management Systems

37 oliatsou Street, Corinthos 20100, Greece
solomon_antoniou@yahoo.com


Dedicated to Gelly
Abstract
We introduce a solution procedure for the Hamilton-Jacobi-Bellman (HJB)
equation associated to a portfolio optimisation problem. The HJB equation is
derived under the principle of Dynamic Programming. The solution method relies
on determining the underlying Lie point symmetries of the equation. On finding
the symmetries, we consider a linear combination of the infinitesimal generators,
and the two invariants that they determine. Using the transformations based on the
two invariants, we convert the HJB equation to an ordinary non-linear differential
equation, which can in turn be converted to an Abel differential equation. Abels
differential equation admits a closed form solution. What follow are twelve
families of solutions.

Keywords: Stochastic Control, Hamilton-Jacobi-Bellman equation, Portfolio
Optimization, Nonlinear PDEs, Lie Symmetries, Closed-Form Solutions.
2

1. Introduction
Stochastic Control (Bertsekas [6], [7], Evans [19], Fleming and Soner [20],
Ingersoll [28], ksendal [42], Pham [46], Soner [49], Touzi [52]) is an
optimisation procedure used in many areas of financial applications, such as
- Portfolio Optimization (Benth and Karlsen [5], Korn and Korn [31], Korn
[32], Kraft [33])
- Option Pricing (Baron and Jensen [3])
- Consumption-Investment Strategies (Davis, Panas and Zariphopoulou [15],
Elliott and Kopp [18], Karatzas, Lehoczky, Sethi and Shreve [29],
Karatzas, Lehoczky and Shreve [30] and Zariphopoulou [53])
- Stochastic Interest Rates (Lewis [36])
- Bond Pricing (Kraft [33]) and Bond Portfolio Optimization (Puhle [47])
- Asset Allocation (Munk [41])
- Risk (Bielecki and Pliska [8], Dmitrasinovic-Vivodic, Lari-Lavassani, Li
and Ware [16])
- DSGE models (Papanicolaou [45])
- Pairs Trading (Mudchanatongsuk, Primbs and Wong [40])
- Pension Funds (Boulier, Trussant and Florens [13], Gerrard, Haberman and
Vigna [21])
- Insurance (Hipp, [24])
- Debt Crises (Stein, [50])
- Various applications (Bucci et al. [14])
The basic equation used in the optimization process is the Hamilton-Jacobi-
Bellman (HJB) equation, derived under the principle of Dynamic Programming
(Bellman [4]). Despite successful predictions of the HJB equation for such
models, there is no available general solution procedure. The solutions obtained so
far are based on separation of variables. It is the purpose of this paper to introduce
3
a solution procedure (and to find some general solutions) based on Lie
Symmetries.
The Lie symmetry approach in solving differential equations was introduced by S.
Lie (Lie [37] and Lie [38]) and is best described in references Anderson and
Ibragimov [1], Bluman and Kumei [9], Dresner [17], Hereman [23], Ibragimov
[25], Ibragimov [26], Olver [43], Ovsiannikov [44] and Stephani [51]. This
technique was used for the first time in Finance by Ibragimov and Gazizov [27].
The same technique was also used by the author in solving the Bensoussan-
Crouhy-Galai equation, which models the stochastic equity volatility (Antoniou
[2]). There is however a growing list of papers in applying Lie symmetry methods
to Finance. For a (non-complete) set of references, see Bordag [10], Bordag and
Chmakova [11], Bordag and Frey [12], Goard [22], Leach, OHara and Sinkala
[35] and Silberberg [48].
The paper is organized as follows: In section 2 we consider a simple model, which
leads to the Hamilton-Jacobi-Bellman equation. In section 3 the Lie symmetry
analysis to this equation is performed. In other words we find the infinitesimal
generators of the Lie group. In section 4 we find general solutions to the equation,
by first considering a linear combination of the infinitesimal generators and then
by determining the invariants of the equation. The invariants allow us to convert
the equation into a nonlinear, second order ordinary differential equation. Using
another transformation, we convert this nonlinear equation to an Abel equation
possessing a closed-form solution. In section 5 we present our conclusions and the
twelve families of our solution.

2. A Portfolio Selection Model and the HJB Equation
In this section we consider a selection portfolio model, optimized under the
principle of Dynamic Programming, leading to an HJB equation.
The model we consider is a Brownian model, in which the money market account
and stocks are modeled by
4
dt ) t ( r ) t ( S ) t ( S d
0 0
= , 1 ) 0 ( S
0
= (2.1)
)] t ( dW dt ) t ( [ ) t ( S ) t ( S d + = , 0 ) 0 ( S > (2.2)
The coefficients r, and are progressively measurable processes being
uniformly bounded. Let also
) t ( : be the number of the stocks invested at time t.
) t ( S ) t (
0 0
: be the money invested in the money market account at time t
) t ( S ) t ( ) t ( S ) t ( ) t ( X
0 0

+ = : be the wealth of the investor

) t ( X
) t ( S ) t (
) t ( = : be the proportion invested in stock
) t ( 1 : be the proportion invested in the money market account.
The following proposition holds true (see for example Kraft [33], [34] or ksendal
[42]).
Proposition. The wealth dynamics of a self-financing trading strategy is described
by the so-called wealth equation
)] t ( dW dt )) r ( r [( ) t ( X ) t ( dX + + = (2.3)

0
x ) 0 ( X = ( 0 x
0
> )
We come now to the portfolio optimization one investor has with initial wealth
0 x ) 0 ( X
0
> = and would like to have optimal final wealth ) T ( X
*
under an
optimal final strategy * . For a given initial wealth 0 x
0
> , the investor
maximizes the following utility functional
))] ( X ( U [ E sup

A e
(2.4)
where
: { A = admissible and <

] )) ( X ( U [ E

}
and ) t ( X

is given by (2.3):
| | ) t ( dW ) t ( dt )] ) t ( r ) t ( ( ) t ( ) t ( r [ ) t ( X ) t ( dX

+ + =
5

0

x ) 0 ( X =
The function ) x ( U , defined for positive real numbers, is called the utility
function, which is strictly concave, strictly increasing and continuously
differentiable, and satisfies the conditions
= ' = '
+
) x ( U lim ) 0 ( U
0 x
, 0 ) x ( U lim ) ( U
x
= ' = '
|

Let us define the value function
))] ( X ( U [ E sup ) x , t ( G
x , t
A e
=
where
] x ) t ( X | )) ( X ( U [ E ))] ( X ( U [ E
x , t
= =
) x ( U ) x , t ( G =
Suppose now that there is an optimal strategy * . The corresponding HJB
equation, which maximizes the final wealth, derived under the principle of
Dynamic Programming, is given by
0 ) x , t ( G x
2
1
x ] ) r ( r [ ) x , t ( G sup ) x , t ( G
xx
2 2 2
x t
=
)
`

t o + t + +
t
(2.5)
for any admissible strategy and terminal condition ) x ( U ) x , T ( G = .
We consider the case where r, and are all constants.
Pointwise maximization over yields the first order condition
0 ) t ( ) x , t ( G x x ) r ( ) x , t ( G
xx
2 2
x
= + (2.6)
which implies that the optimal strategy is given by

) x , t ( G x
) x , t ( G

r
*
xx
x
2

= (2.7)
Since the derivative of (2.6) with respect to is ) x , t ( G x
xx
2 2
, the candidate
* is the global maximum if 0 G
xx
< .
Substituting * into the HJB equation (2.5), yields a PDE for ) x , t ( G :
6
0
) x , t ( G
) x , t ( G
k
2
1
) x , t ( G x r ) x , t ( G
xx
2
x 2
x t
= + (2.8)
where

r
k

= .
The traditional way of solving equation (2.8) is by separation of variables. In fact,
considering that (Merton [39], ksendal [42])

1
) t ( f x

1
) x , t ( G

= (2.9)
equation (2.8) yields the first order differential equation
) t ( f K ) t ( f = ' (2.10)
where
|
|
.
|

\
|

+

=
2
k
) 1 ( 2
1
r
1
K (2.11)
The above differential equation (2.10) has the solution
) t T ( K
e ) t ( f

= , and
satisfies the condition 1 ) T ( f = . Therefore solution (2.9) is compatible with the
condition

1
) x ( U ) x , T ( G = . From (2.9) and (2.7) we determine the value
function and the optimal strategy respectively. For the type of solution we have
obtained, we can check that 0 G
xx
< for 1 < .
In section 4 we provide our own method of solution, based on Lie Symmetry
Analysis.

3. Lie Symmetry Analysis of the HJB Equation
We now consider the HJB equation (2.8) written in the equivalent form
0 u k
2
1
u u x r u u
2
x
2
xx x xx t
= + (3.1)
where we have changed the notation of the function from ) x , t ( G to the more
traditional notation ) t , x ( u .
7
We are going to perform a Lie symmetry analysis of this equation. By this we
mean that we shall determine the infinitesimal generators of the Lie symmetry
group. These would then be used to determine the invariants, needed to convert
the partial differential equation into an ordinary differential equation.
We introduce the following concepts and notation (Olver [43]). Consider the base
space M, which is the Cartesian product U X of a 2-dimensional space X of
independent variables X ) t , x ( e by a 1-dimensional space U of dependent
variables U u e . Let
) 1 (
U be the space of the first derivatives of the functions
) t , x ( u with respect to x and t:
) 1 (
t x
U ) u , u ( e . Let also
) 2 (
U be the space of the
second derivatives of the functions ) t , x ( u with respect to x and t:
) 2 (
tt xt xx
U ) u , u , u ( e . Since the differential equation (3.1) is second order, we
introduce a second order jet bundle
) 2 (
M by considering the Cartesian product

) 2 ( ) 1 ( ) 2 (
U U M M =
The coordinates of the space
) 2 (
M are labeled by

) 2 (
tt xt xx t x
M ) u , u , u , u , u , u , t , x ( z e =
In the space
) 2 (
M , equation (3.1) can be expressed as 0 ) u , t , x (
) 2 (
= where

2
x
2
xx x xx t
) 2 (
u k
2
1
u u x r u u ) u , t , x ( + = (3.2)
Let

L be the solution manifold of (3.1):

) 2 ( ) 2 (

M } 0 | M z { L c = e =
A symmetry group

G of equation 0 = is defined by
} L L : g | ) M ( Diff g { G

) 2 (

e =
We want to determine a subgroup of ) M ( Diff
) 2 (
, compatible with the structure of

L . We shall first find the symmetry Lie algebra ) ( Diff ) ( Diff

) 2 ( ) 2 (

c and
then use the main Lie theorem to determine

G . Let us denote by V
8
( ) ( Diff Ve ) an element of a vector field on M (the generator of Lie
symmetries), defined by

u
) u , t , x (
t
) u , t , x (
x
) u , t , x ( V
c
c
+
c
c
+
c
c
= (3.3)
where ) u , t , x ( ), u , t , x ( and ) u , t , x ( are smooth functions of their arguments.
The infinitesimal generators of

G ge will have the structure of (3.3) and will

form an algebra ) ( Diff

. The algebra ) ( Diff

) 2 (

will be spanned by the

vectors V pr
) 2 (
, the second prolongation of V, defined by

tt
tt
xt
xt
xx
xx
t
t
x
x ) 2 (
u

u
V V pr
c
c
+
c
c
+
c
c
+
c
c
+
c
c
+ =
The symmetries are determined by the equation (Olver [42], Theorem 2.31)
0 )] u , t , x ( [ V pr
) 2 ( ) 2 (
= (3.4)
as long as
0 ) u , t , x (
) 2 (
= (3.5)
We implement next the equation 0 )] u , t , x ( [ V pr
) 2 ( ) 2 (
= . We have that
0 )] u , t , x ( [ V pr
) 2 ( ) 2 (
=
0 ] u k
2
1
u u x r u u [ V pr
2
x
2
xx x xx t
) 2 (
= +
or
+ + +
xx
t
x
2
xx
x
xx x
u ) u k u x r ( ) u u r (
0 ) u x r u (
x t
xx
= + + (3.6)
The coefficients
x
,
t
and
xx
are calculated to be (Olver [43], Example
2.38)
t x u t x
2
x u x x u x
x
u u u u u ) ( + =
2
t u t x u t t u x t t
t
u u u u ) ( u + =
9
+ + =
2
x xu uu t xx x xx xu xx
xx
u ) 2 ( u u ) 2 (
+
xx x u t
2
x uu
3
x uu t x xu
u ) 2 ( u u u u u 2

xt x u xx t u xx x u xt x
u u 2 u u u u 3 u 2
The functions , and have the following dependence
) t ( = , ) t , x ( = ) u , t , x ( =
Equation (3.6) thus becomes
+ + + } u ) ( { ) u k u x r ( ) u u r (
x x u x x
2
xx xx x

+ + +
t xx t u xx x t t
u u ) ( u } u {
+ + + +
2
x uu x xx xu xx
u u ) 2 ( {
+ +
t xx x u
u } u ) 2 (
+ + + +
2
x uu x xx xu xx x
u u ) 2 ( { u x r
0 } u ) 2 (
xx x u
= + (3.7)
We now have to take into account the condition 0 ) u , t , x (
) 2 (
= . We therefore
substitute
t
u by
xx
2
x 2
x
u
u
k
2
1
u x r + in the previous equation (3.7):
+ + + } u ) ( { ) u k u x r ( ) u u r (
x x u x x
2
xx xx x

+
|
|
.
|

\
|
+ t | + | +
xx
2
x 2
x xx t u xx x t t
u
u
k
2
1
u x r u ) ( u ) u (
+ + + +
2
x uu x xx xu xx
u u ) 2 ( {
+
|
|
.
|

\
|
+ | +
xx
2
x 2
x xx x u
u
u
k
2
1
u x r } u ) 2 (
+ + + +
2
x uu x xx xu xx x
u u ) 2 ( { u x r
0 } u ) 2 (
xx x u
= + (3.8)
10
We equate all the coefficients of the function u and their derivatives in the
previous equation (after multiplying by
xx
u ) to zero:
Coefficient of
4
x
) u ( :
0 k
2
1
uu
2
= (3.9)
Coefficient of
3
x
) u ( :
0 ) 2 ( k
2
1
xx xu
2
= (3.10)
Coefficient of
2
x
) u ( :
0 k
2
1
xx
2
= (3.11)
Coefficient of
xx x
u u :
0 k
x
2
= (3.12)
Coefficient of
xx
2
x
u ) u ( :
0 ) t ( k
2
1
2
= ' (3.13)
Coefficient of
2
xx
) u ( :
0 x r
t x
= + (3.14)
Coefficient of
2
xx x
) u ( u :
0 ) ) t ( ( x r r
x t
= t' + (3.15)
Equations (3.9)-(3.15) are the determining equations of the Lie symmetries of
equation (3.1). We are now going to solve the system of equations (3.9)-(3.15).
From equation (3.9) we get that 0
uu
= , which means that is a linear function
with respect to u:
) t , x ( u ) t , x ( ) u , t , x ( + = (3.16)
From equation (3.12) we get that 0
x
= . Therefore, using (3.16), we have
11
0 u
x x
= +
from which we get 0
x
= and 0
x
= . Therefore the functions and
introduced in (3.16) are independent of x. On the other hand, since 0
x
= , we
get from (3.14) that 0
t
= . Therefore 0 u
t t
= + , from which we have that
0
t
= and 0
t
= , which means that functions and are constants. We then
obtain that

2 1
a u a ) u , t , x ( + = (3.17)
Equation (3.11) then becomes an identity.
We now get from (3.13) that 0 ) t ( = ' . Therefore ) t ( is a constant:

3
a ) t ( = (3.18)
We get from (3.10), because of (3.17), that 0
xx
= . Therefore ) t , x ( is a linear
function with respect to x:
) t ( g x ) t ( f ) t , x ( + = (3.19)
where ) t ( f and ) t ( g are functions to be determined.
Using the previous expression, equation (3.15) becomes
0 )) t ( g ) t ( g r ( x ) t ( f = ' + '
from which we get , since this equation should be true for any x, that
0 ) t ( f = ' and 0 ) t ( g ) t ( g r = '
We thus have

4
a ) t ( f = (3.20)
and

t r
5
e a ) t ( g = (3.21)
Therefore the function ) t , x ( takes the form

t r
5 4
e a x a ) t , x ( + = (3.22)
Relations (3.22), (3.18) and (3.17) allow us to write down the generator of the
symmetries:
12

u
) a u a (
t
a
x
) e a x a ( V
2 1 3
t r
5 4
c
c
+ +
c
c
+
c
c
+ =

(3.23)
Therefore we have the following
Theorem 1. The Lie algebra of the infinitesimal transformations of the HJB
equation (3.1) is spanned by the five vector fields

u
u X
1
c
c
= (3.24)

u
X
2
c
c
= (3.25)

t
X
3
c
c
= (3.26)


x
x X
4
c
c
= (3.27)

x
e X
t r
5
c
c
= (3.28)

4. General Solutions to the HJB Equation
In order to find a solution to the HJB equation (3.1), we have to determine the
invariants of the equation. For this purpose we consider a linear combination of
the above found generators of the symmetries.
We consider the combination

2 1 5 4 3
X X + + + +
In other words we consider the generator

u
) u (
x
) e x (
t
t r
c
c
+ +
c
c
+ +
c
c
(4.1)
where the coefficients , , and will be determined on the basis of finding
closed form solutions to the equation. The parameter appearing in (4.1) not to
be confused with appearing in the definition of k after equation (2.8).
Based on (4.1), we consider the system
13

u
du
e x
dx
1
dt
t r
+
=
+
= (4.2)
In order to solve the first equation

t r
e x
dx
1
dt
+
= (4.3)
of the above system, we have to consider two cases: r = and r = . Details are
given in the Appendix.
4.1. Case 1. Solution of the HJB equation in the r = case.
If r = , equation (4.3) has the general solution

t ) r ( t
1
e
r

x e C

= (4.4)
Therefore one invariant of the HJB equation (3.1) is given by

t ) r ( t
e
r

x e y

= (4.5)
The equation

u
du
1
dt
+
=
has the general solution
) u ln( t C
2
+ = + .
Therefore another invariant is given by ) y ( = , where
) e (

1
u
t
= (4.6)
Using (4.5) and (4.6), we find that the partial derivatives of the function u
transform as

t
y
t ) r (
t
e e
r

1
u
)
`

+ =

(4.7)

y
t ) r (
x
e

1
u

= (4.8)
14

yy
t ) 2 r (
xx
e

1
u

= (4.9)
Using (4.7)-(4.9), the original HJB equation (3.1) is transformed into
0 ) ( k
2
1
y ) r (
2
y
2
yy y yy
= + (4.10)
which is a nonlinear, second order ordinary differential equation.
Under the transformation

) y ( w
y
= (4.11)
equation (4.10) takes on the form
0 w y ) r ( w k
2
1
w ] w y ) r ( [
3 2 2
y
= +
|
.
|

\
|
+ + (4.12)
which is an Abel differential equation.
Introducing the notation

2
k
2
1
= and r = ( 0 = o ) (4.13)
equation (4.12) can be written as

w y
w y w
w
3 2
y
+
+
= (4.14)
which, in turn, under the substitution

) y ( Z
1
) y ( w = (4.15)
takes on the form

y ) y ( Z
y ) y ( Z
Z
y
o + v
o +
= (4.16)
Introducing the function ) y ( V by
) y ( V y ) y ( Z = (4.17)
we transform equation (4.16) into the equation
15
V
V
V y V
y
+
+
= +
which is equivalent - after separating variables - to the equation

y
1
V
V ) ( V
V
y
2
=
o o + v
o + v
(4.18)
4.1.I. Let 0 = , i.e.
2
k
2
1
= v ( 0 > v ). Equation (4.18) can be written as

y
1
V
V V
V
y
2
=
o o + v
o + v
(4.19)
Denoting by vo + o 4 D
2
the discriminant of the trinomial o o + v V V
2
, we
have the following:
4.1.Ia For 0 D > , i.e. < v + < 4 r r or v + < < 4 r r , equation (4.19) admits a
solution given implicitly by
A y ln | V | ln
) (
| V | ln
) (
+ =
q v
o + v
q
q v
o + q
(4.20)
where and q are the two real roots of the trinomial, given by

v
+ o
=
2
D
and
v
o
= q
2
D

respectively and A is an arbitrary constant.
4.1.Ib For 0 D< , i.e. v + < < 4 r r , equation (4.19) admits a solution given
implicitly by
A y ln
p
V
arctan
p
) p ) V ln((
2
1
2 2
+ =
|
|
.
|

\
| +
v
v o
+ + + (4.21)
where and p are two parameters defined by

v
o
=
2
and
v

=
2
D
p
respectively and A is an arbitrary constant.
16
4.1.Ic For 0 D = , i.e. v = o 4 , equation (4.19) admits a solution given implicitly
by
A y ln | 2 V | ln
2 V
1
2 + = +

|
.
|

\
|
+
v
o
(4.22)
where A is an arbitrary constant.
4.1.II. Let 0 = , i.e.
2
k
2
1
= v . We shall distinguish two cases: o = and o = .
4.1.IIa If o = , equation (4.18) becomes
y
1
V
V
V
y
2
=
o v
o + v

In this case we have to consider two cases: o = v and o = v . In the former case
we may set either
2
e v = o or
2
e v = o , 0 > e .
We thus have the following:
4.1.IIa1 For
2
e v = o , we have to solve the equation

y
1
V
V
V
y
2 2
2
=
e
e +

which gives upon integration
A y ln
V
V
ln
2
1
) V ln(
2
1
2 2
+ =
|
.
|

\
|
e +
e
e + e (4.23)
where A is an arbitrary constant.
4.1.IIa2. For
2
e v = o , we have to solve the equation

y
1
V
V
V
y
2 2
2
=
e +
e

which gives upon integration
A y ln
V
arctan ) V ln(
2
1
2 2
+ =
e
e e + (4.24)
where A is an arbitrary constant.
4.1.IIa3. For v = o , we obtain the equation
17

y
1
V
1 V
1 V
y
2
=

+
or
y
1
V
1 V
1
y
=

and by integration,
A y ln | 1 V | ln + = (4.25)
where A is an arbitrary constant.
4.1.IIb. If o = , denoting by vo + o 4 ) ( D
2
the discriminant of the trinomial
o o + v V ) ( V
2
, we have the following:
4.1.IIb1. For 0 4 ) ( D
2
> vo + o , equation (4.18) admits a solution given
implicitly by
A y ln | V | ln
) (
| V | ln
) (
+ =
q v
o + v
q
q v
o + q
(4.26)
where and q are the two real roots of the trinomial, given by

v
+ o
=
2
D
and
v
o
= q
2
D

respectively and A is an arbitrary constant.
4.1.IIb2. For 0 4 ) ( D
2
< vo + o , equation (4.18) admits a solution given
implicitly by
A y ln
p
arctan
p
) p ) V ln((
2
1
2 2
+ =
+ v
v
v o
+ + + (4.27)
where and p are two parameters defined by

v
o
=
2
and
v

=
2
D
p
respectively and A is an arbitrary constant.
4.1.IIb3. For 0 4 ) ( D
2
= vo + o , equation (4.18) admits a solution given
implicitly by
A y ln ) V ln(
V
1
+ = + +
+
|
.
|

\
|
v
o
(4.28)
18
where is the double root of the trinomial given by

v
o
=
2

and A is an arbitrary constant.

The function ) y ( = is then determined integrating (compare (4.11), (4.15) and
(4.17))

) y ( V y
1 y
=
u
u
(4.29)
where ) y ( V is implicitly provided by any of the (4.20)-(4.28) equations.
Therefore we find that

|
|
.
|

\
|


= u
}
y
y
0
) ( V
d
exp B ) y ( (4.30)
where B is a constant.
4.2. Case 2. Solution of the HJB equation in the r = case.
In this case the system (4.2) is given by

+ v
=
+
=
u
du
e x r
dx
1
dt
t r
(4.31)
The previous system has the general solutions:
t e x C
t r
1
=

(4.32)
and
) u ln( t C
2
+ = + (4.33)
Therefore in this case we have the two invariants
t e x y
t r
=

(4.34)
and
) e (

1
u
t
= (4.35)
19
where ) y ( = .
Using (4.34) and (4.35), we find that the partial derivatives of the function u
transform as

t
y t
e ] ) t y ( r [

1
u
)
`

+ = (4.36)

y
t ) r (
x
e

1
u

= (4.37)

yy
t ) r 2 (
xx
e

1
u

= (4.38)
Substituting (4.36)-(4.38) into the original equation (3.1), we find that the function
) y ( = satisfies the equation
0 ) ( k
2
1

2
y
2
yy y yy
= + (4.39)
which is a nonlinear, second order ordinary differential equation.
Under the transformation

) y ( w
y
= (4.40)
equation (4.39) takes the form

3 2
y
w w w ) w ( = + v (4.41)
which is an Abel differential equation. This equation may also be treated as an
equation with separable variables. However it will here be considered as an Abel
differential equation, since in that case we obtain simpler expressions as solutions.
In solving (4.38), we shall consider two cases: 0 = and 0 = .
4.2.I. If 0 = , we find that the general solution to the equation (4.41) is given by

A y

) y ( w
+
= (4.42)
where A is an arbitrary constant. Integrating further

) y ( w
y
= , we find that
20

) A y ( B ) y ( + = (4.43)
where B is an arbitrary constant.
4.2.II. If 0 = , equation (4.37) takes the form

w
w w
w
3 2
y
+
+
= (4.44)
4.2.IIa. If 0 = , under the substitution



=
) y ( Y
) y ( w (4.45)
equation (4.44) takes the form

) ( Y ) (
Y

2
y
+
= ( = )
and by integration we obtain
A y Y ln ) ( Y ) (
2
+ = + (4.46)
where A is an arbitrary constant.
Therefore ) y ( is the solution to the equation

Y

=
u
u
) y (
y
(4.47)
where ) y ( is given implicitly by (4.46). Therefore we find that

|
|
.
|

\
|
Y

= u
}
y
y
0
) (
d
exp B ) y ( (4.48)
where B is an arbitrary constant.
4.2.IIb. For 0 = (i.e.
2
k
2
1
= ), equation (4.41) becomes

w
w
w
3
y
+
= (4.49)
Under the substitution
21
) y ( X
1
w =
the above equation (4.49) takes the form

+ v

=
X
X
y

which has the general solution
A y 2 2
2
+ = X + X v (4.50)
where A is a constant.
Therefore ) y ( is the solution to the equation

) y ( X
1

y
= (4.51)
where ) y ( X is given implicitly by (4.50). Hence, we find that

|
|
|
.
|

\
|
=
}
y
y
0
) ( X
d
exp B ) y ( (4.52)
where B is a constant.
5. Conclusions and Discussion.
Gathering the results of the previous section, we arrive at the following
Theorem 2. The HJB equation (3.1) admits the following twelve families of
general solutions:
Solution I.
C
) ( V
d
exp e B ) t , x ( u
y
y
t
0
+
|
|
.
|

\
|


=
}
v
(5.1)

t ) r ( t
e
r

x e y

= ( 0 = ) , r = (5.2)
where ) y ( V is a function defined implicitly by
A y ln | ) y ( V | ln
) (
| ) y ( V | ln
) (
+ =
q v
o + v
q
q v
o + q
(5.3)
22
The parameters and q are defined by

v
+ o
=
2
D
and
v
o
= q
2
D
(5.4)
respectively, where r = ( 0 = o ) and vo + o 4 D
2
. The parameter v is such
that
2
k
2
1
= v ( 0 > v ) and the parameter satisfies either one of the inequalities
< v + < 4 r r or v + < < 4 r r .
Solution II
C
) ( V
d
exp e B ) t , x ( u
y
y
t
0
+
|
|
.
|

\
|


=
}
v
(5.5)

t ) r ( t
e
r

x e y

= ( 0 = ) , r = (5.6)
where ) y ( V is a function defined implicitly by
A y ln
p
) y ( V
arctan
p
) p ) ) y ( V ln((
2
1
2 2
+ =
+
v
v o
+ + + (5.7)
The parameters and p are defined by

v
o
=
2
and
v

=
2
D
p (5.8)
respectively, where r = ( 0 = o ) and vo + o 4 D
2
.
The parameter v is such that
2
k
2
1
= v ( 0 > v ) and the parameter takes values
within the range v + < < 4 r r .
Solution III.
C
) ( V
d
exp e B ) t , x ( u
y
y
t
0
+
|
|
|
.
|

\
|

=
}
(5.9)

t ) r ( t
e
r

x e y

= ( 0 = ) , r = (5.10)
23
where ) y ( V is a function defined implicitly by
A y ln | 2 ) y ( V | ln
2 ) y ( V
1
2 + = +

|
.
|

\
|
+
v
o
(5.11)
The parameter o is defined by r = ( 0 = o ) and satisfies the equation
v = o 4 . The parameter v is such that
2
k
2
1
= v ( 0 > v ).
Solution IV
C
) ( V
d
exp e B ) t , x ( u
y
y
t
0
+
|
|
|
.
|

\
|

=
}
(5.12)

t ) r ( t
e
r

x e y

= ( 0 = ) , 0 = , o = (5.13)
where ) y ( V is a function defined implicitly by
A y ln
) y ( V
) y ( V
ln
2
1
) ) y ( V ln(
2
1
2 2
+ =
e +
e
e + e (5.14)
where
2
= , r = ( 0 = o ) and
2
k
2
1
= v .
Solution V
C
) ( V
d
exp e B ) t , x ( u
y
y
t
0
+
|
|
.
|

\
|


=
}
v
(5.15)

t ) r ( t
e
r

x e y

= 0 = , 0 = , o = (5.16)
where ) y ( V is a function defined implicitly by
A y ln
) y ( V
arctan ) ) y ( V ln(
2
1
2 2
+ =
e
e e + (5.17)
The parameter e is defined through
2
e v = o where r = ( 0 = o ) and
2
k
2
1
= v

24
Solution VI
C
) ( V
d
exp e B ) t , x ( u
y
y
t
0
+
|
|
.
|

\
|


=
}
v
(5.18)

t ) r ( t
e
r

x e y

= 0 = , 0 = , o = (5.19)
where ) y ( V is a function defined implicitly by
A y ln | 1 ) y ( V | ln + = (5.20)
The parameters satisfy v = o , r = ( 0 = o ) and
2
k
2
1
= v .
Solution VII
C
) ( V
d
exp e B ) t , x ( u
y
y
t
0
+
|
|
.
|

\
|


=
}
v
(5.21)

t ) r ( t
e
r

x e y

= ( 0 = ) (5.22)
where ) y ( V is a function defined implicitly by
A y ln | ) y ( V | ln
) (
| ) y ( V | ln
) (
+ =
q v
o + v
q
q v
o + q
(5.23)
The parameters are given by
v
+ o
=
2
D
,
v
o
= q
2
D
and 0 4 ) ( D
2
> vo + o ,
o = and 0 = , where
2
k
2
1
= and r = ( 0 = o )
Solution VIII
C
) ( V
d
exp e B ) t , x ( u
y
y
t
0
+
|
|
.
|

\
|


=
}
v
(5.24)

t ) r ( t
e
r

x e y

= ( 0 = ) (5.25)
25
where ) y ( V is a function defined implicitly by
A y ln
p
) y ( V
arctan
p
) p ) ) y ( V ln((
2
1
2 2
+ =
+
v
v o
+ + + (5.26)
The parameters are given by

v
o
=
2
,
v

=
2
D
p , 0 4 ) ( D
2
< vo + o , o = and 0 =
where
2
k
2
1
= and r = ( 0 = o )
Solution IX
C
) ( V
d
exp e B ) t , x ( u
y
y
t
0
+
|
|
.
|

\
|


=
}
v
(5.27)

t ) r ( t
e
r

x e y

= ( 0 = ) (5.28)
where ) y ( V is a function defined implicitly by
A y ln ) ) y ( V ln(
) y ( V
1
+ = + +
+
|
.
|

\
|
v
o
(5.29)
The parameters are given by

v
o
=
2
, 0 4 ) ( D
2
= vo + o , o = and 0 =
where
2
k
2
1
= and r = ( 0 = o )
Solution X
C ) A y ( e B ) t , x ( u

t
+ + = (5.30)
where

t r
e x y

= (5.31)
26
A, B, C are arbitrary constants and is a free parameter with 0 = , and
2
k
2
1
= with 0 = .
Solution XI
C
) (
d
exp e B ) t , x ( u
y
y
t
0
+
|
|
.
|

\
|
Y

=
}
v
(5.32)
where ) y ( Y is a function defined implicitly by
A y ) y ( Y ln ) ( ) y ( Y ) (
2
+ = + ( 0 = ) (5.33)
and
t e x y
t r
=

( 0 = ) (5.34)
A, B, C are arbitrary constants and , are free parameters with 0 = , 0 = , and
2
k
2
1
= with 0 = .
Solution XII
C
) ( X
d
exp e B ) t , x ( u
y
y
t
0
+
|
|
|
.
|

\
|
=
}
(5.35)
where ) y ( X is a function defined implicitly by
A y 2 ) y ( 2 ) y (
2
+ = X + X v (5.36)
and
t e x y
t r
=

( 0 = ) (5.37)
provided that
2
k
2
1
= ( 0 = ). A, B, C are arbitrary constants and , are free
parameters with 0 = , 0 = .
Only one solution that has been dealt with in the literature so far. It is the solution
(5.30)-(5.31). The equation (2.9) is a member of this family of solutions when we
27
choose to place 0 C A = = and 1 B= , and an obvious adjustment (and renaming)
of the parameters, using the same boundary condition

1
) x ( U ) T , x ( u =
The other solutions appear for the first time in this paper. It is obvious that the
parameters and the various constants need to be adjusted to match the appropriate
boundary conditions. It remains to be seen if the general solutions found in this
article are to have any practical interest in Finance and Stochastic Control.
In any case, the Hamilton-Jacobi-Bellman equation associated to an optimization
problem seems to have a rich mathematical structure and thus deserves further
investigation.
Appendix. Solution of equation (4.3).
Equation (4.3) can be written as
0 dt ) e x ( x d
t r
= + (A.1)
Using standard methods, we find that equation (A.1) admits
t
e

as an integrating
factor. Therefore we have to find the general solution of the complete first order
differential equation
0 dt ) e e x ( dx e
t ) r ( t t
= +

(A.2)
We suppose that (A.2) admits a solution of the form
C ) t , x ( U = (A.3)
Since
0 dx
x
U
dt
t
U
dU =
c
c
+
c
c
= (A.4)
and on comparing this equation with (A.2), we obtain the following system of
differential equations

t ) r ( t
e e x
t
U

=
c
c
(A.5)
28

t
e
x
U

=
c
c
(A.6)
Integrating (A.5) with respect to t, we need to distinguish two cases:
= r and = r .
A1. If = r , we obtain from equation (A.5) the solution
) x ( e
r
e x U
t ) r ( t
u +

=

(A.7)
where ) x ( u is a function to be next determined. From (A.7)
) x ( e
x
U
t
u' + =
c
c

(A.8)
(comparing (A.8) to (A.6)) we find that 0 ) x ( = u' , i.e.
1
C ) t ( = u . Therefore, using
(A.7) and (A.3), we obtain the following solution of (4.3) when = r :
C e
r
e x
t ) r ( t
=

(A.9)
which is equation (4.4).
A2. If = r , we get from (A.5)
=
c
c
t
e x
t
U
(A.10)
which upon integration with respect to t gives us
) x ( t e x U
t
q + =

(A.11)
where ) x ( q is a function to be determined next.
From (A.11)
) x ( e
x
U
t
q' + =
c
c

(A.12)
(comparing (A.12) to (A.6)), we get 0 ) x ( = q' , i.e.
2
C ) t ( = q . Therefore using
(A.11) and (A.3), we get the following solution of (4.3) when = r :

2
t r
C t e x =

(A.13)
which is equation (4.34).
29

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