60,171 research outputs found
A New Efficient Numerical Method for Solving American Option under Regime Switching Model
[EN] A system of coupled free boundary problems describing American put option pricing under regime switching is considered. In order to build numerical solution firstly a front-fixing transformation is applied. Transformed problem is posed on multidimensional fixed domain and is solved by explicit finite difference method. The numerical scheme is conditionally stable and is consistent with the first order in time and second order in space. The proposed approach allows the computation not only of the option price but also of the optimal stopping boundary. Numerical examples demonstrate efficiency and accuracy of the proposed method. The results are compared with other known approaches to show its competitiveness.This work has been partially supported by the European Union in the FP7- PEOPLE-2012-ITN program under Grant Agreement Number 304617 (FP7 Marie Curie Action, Project Multi-ITN STRIKE-Novel Methods in Computational Finance) and the Ministerio de Economia y Competitividad Spanish grant MTM2013-41765-P.Egorova, V.; Company Rossi, R.; Jódar Sánchez, LA. (2016). A New Efficient Numerical Method for Solving American Option under Regime Switching Model. Computers and Mathematics with Applications. 71:224-237. https://doi.org/10.1016/j.camwa.2015.11.019S2242377
Pricing Financial Derivatives using Radial Basis Function generated Finite Differences with Polyharmonic Splines on Smoothly Varying Node Layouts
In this paper, we study the benefits of using polyharmonic splines and node
layouts with smoothly varying density for developing robust and efficient
radial basis function generated finite difference (RBF-FD) methods for pricing
of financial derivatives. We present a significantly improved RBF-FD scheme and
successfully apply it to two types of multidimensional partial differential
equations in finance: a two-asset European call basket option under the
Black--Scholes--Merton model, and a European call option under the Heston
model. We also show that the performance of the improved method is equally high
when it comes to pricing American options. By studying convergence,
computational performance, and conditioning of the discrete systems, we show
the superiority of the introduced approaches over previously used versions of
the RBF-FD method in financial applications
Optimal stopping problems in mathematical finance
This thesis is concerned with the pricing of American-type contingent claims. First, the explicit solutions to the perpetual American compound option pricing problems in the Black-Merton-Scholes model for financial markets are presented. Compound options are financial contracts which give their holders the right (but not the obligation) to buy or sell some other options at certain times in the future by the strike prices given. The method of proof
is based on the reduction of the initial two-step optimal stopping problems for the underlying geometric Brownian motion to appropriate sequences of ordinary one-step problems. The latter are solved through their associated one-sided free-boundary problems and the subsequent martingale verification for ordinary differential operators. The closed form solution to the perpetual
American chooser option pricing problem is also obtained, by means of the analysis of the equivalent two-sided free-boundary problem. Second, an extension of the Black-Merton-Scholes model with piecewise-constant dividend
and volatility rates is considered. The optimal stopping problems related to the pricing of the perpetual American standard put and call options are solved in closed form. The method of proof is based on the reduction of the initial optimal stopping problems to the associated free-boundary problems and the subsequent martingale verification using a local time-space formula. As a result, the explicit algorithms determining the constant hitting thresholds for the underlying asset price process, which provide the optimal exercise boundaries for the options,
are presented. Third, the optimal stopping games associated with perpetual convertible bonds in an extension of the Black-Merton-Scholes model with random dividends under different information flows are studied. In this type of contracts, the writers have a right to withdraw the bonds
before the holders can exercise them, by converting the bonds into assets. The value functions and the stopping boundaries' expressions are derived in closed-form in the case of observable dividend rate policy, which is modelled by a continuous-time Markov chain. The analysis of the associated parabolic-type free-boundary problem, in the case of unobservable dividend rate policy, is also presented and the optimal exercise times are proved to be the first times at which the asset price process hits boundaries depending on the running state of the filtering dividend rate estimate. Moreover, the explicit estimates for the value function and the optimal exercise boundaries, in the case in which the dividend rate is observable by the writers but unobservable by the holders of the bonds, are presented. Finally, the optimal stopping problems related to the pricing of perpetual American options in an extension of the Black-Merton-Scholes model, in which the dividend and volatility rates of the underlying risky asset depend on the running values of its maximum and its maximum
drawdown, are studied. The latter process represents the difference between the running maximum and the current asset value. The optimal stopping times for exercising are shown to be the first times, at which the price of the underlying asset exits some regions restricted by
certain boundaries depending on the running values of the associated maximum and maximum drawdown processes. The closed-form solutions to the equivalent free-boundary problems for the value functions are obtained with smooth fit at the optimal stopping boundaries and normal reflection at the edges of the state space of the resulting three-dimensional Markov process. The optimal exercise boundaries of the perpetual American call, put and strangle options are obtained as solutions of arithmetic equations and first-order nonlinear ordinary differential equations
A method for pricing American options using semi-infinite linear programming
We introduce a new approach for the numerical pricing of American options.
The main idea is to choose a finite number of suitable excessive functions
(randomly) and to find the smallest majorant of the gain function in the span
of these functions. The resulting problem is a linear semi-infinite programming
problem, that can be solved using standard algorithms. This leads to good upper
bounds for the original problem. For our algorithms no discretization of space
and time and no simulation is necessary. Furthermore it is applicable even for
high-dimensional problems. The algorithm provides an approximation of the value
not only for one starting point, but for the complete value function on the
continuation set, so that the optimal exercise region and e.g. the Greeks can
be calculated. We apply the algorithm to (one- and) multidimensional diffusions
and to L\'evy processes, and show it to be fast and accurate
Application of Operator Splitting Methods in Finance
Financial derivatives pricing aims to find the fair value of a financial
contract on an underlying asset. Here we consider option pricing in the partial
differential equations framework. The contemporary models lead to
one-dimensional or multidimensional parabolic problems of the
convection-diffusion type and generalizations thereof. An overview of various
operator splitting methods is presented for the efficient numerical solution of
these problems.
Splitting schemes of the Alternating Direction Implicit (ADI) type are
discussed for multidimensional problems, e.g. given by stochastic volatility
(SV) models. For jump models Implicit-Explicit (IMEX) methods are considered
which efficiently treat the nonlocal jump operator. For American options an
easy-to-implement operator splitting method is described for the resulting
linear complementarity problems.
Numerical experiments are presented to illustrate the actual stability and
convergence of the splitting schemes. Here European and American put options
are considered under four asset price models: the classical Black-Scholes
model, the Merton jump-diffusion model, the Heston SV model, and the Bates SV
model with jumps
Irreversible Investment under L\'evy Uncertainty: an Equation for the Optimal Boundary
We derive a new equation for the optimal investment boundary of a general
irreversible investment problem under exponential L\'evy uncertainty. The
problem is set as an infinite time-horizon, two-dimensional degenerate singular
stochastic control problem. In line with the results recently obtained in a
diffusive setting, we show that the optimal boundary is intimately linked to
the unique optional solution of an appropriate Bank-El Karoui representation
problem. Such a relation and the Wiener Hopf factorization allow us to derive
an integral equation for the optimal investment boundary. In case the
underlying L\'evy process hits any real point with positive probability we show
that the integral equation for the investment boundary is uniquely satisfied by
the unique solution of another equation which is easier to handle. As a
remarkable by-product we prove the continuity of the optimal investment
boundary. The paper is concluded with explicit results for profit functions of
(i) Cobb-Douglas type and (ii) CES type. In the first case the function is
separable and in the second case non-separable.Comment: 19 page
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