A Singular Differential Equation Stemming from an Optimal Control Problem in Financial Economics

Abstract

We consider the ordinary differential equation $x^2 u'' = axu'+bu-c(u'-1)^2, x\in (0,x_0)$, with $a\in\mathbb{R}, b\in\mathbb{R}$, $c>0$ and the singular initial condition $u(0)=0$, which in financial economics describes optimal disposal of an asset in a market with liquidity effects. It is shown in the paper that if $a+b < 0$ then no solutions exist, whereas if $a+b\ge0$ then there are infinitely many solutions with indistinguishable asymptotics near 0. Moreover, it is proved that in the latter case there is precisely one solution $u$ corresponding to the choice $x_0=\infty$ which is such that $0 \le u(x)\le x$ for all $x>0$, and that this solution is strictly increasing and concave.