Nonlinear Parabolic Equations arising in Mathematical Finance

This survey paper is focused on qualitative and numerical analyses of fully nonlinear partial differential equations of parabolic type arising in financial mathematics. The main purpose is to review various non-linear extensions of the classical Black-Scholes theory for pricing financial instruments, as well as models of stochastic dynamic portfolio optimization leading to the Hamilton-Jacobi-Bellman (HJB) equation. After suitable transformations, both problems can be represented by solutions to nonlinear parabolic equations. Qualitative analysis will be focused on issues concerning the existence and uniqueness of solutions. In the numerical part we discuss a stable finite-volume and finite difference schemes for solving fully nonlinear parabolic equations.Comment: arXiv admin note: substantial text overlap with arXiv:1603.0387

Moving boundary transformation for American call options with transaction cost: Finite difference methods and computing

The pricing of American call option with transaction cost is a free boundary problem. Using a new transformation method the boundary is made to follow a certain known trajectory in time. The new transformed problem is solved by various finite difference methods, such as explicit and implicit schemes. Broyden’s and Schubert’s methods are applied as a modification to Newton’s method in the case of nonlinearity in the equation. An alternating direction explicit method with second-order accuracy in time is used as an example in this paper to demonstrate the technique. Numerical results demonstrate the efficiency and the rate of convergence of the methods

A numerical scheme for pricing american options with transaction costs under a jump diffusion process

In this paper we develop a numerical method for a nonlinear partial integro-differential complementarity problem arising from pricing American options with transaction costs when the underlying assets follow a jump diffusion process. We first approximate the complementarity problem by a nonlinear partial integro-differential equation (PIDE) using a penalty approach. The PIDE is then discretized by a combination of a spatial upwind finite differencing and a fully implicit time stepping scheme. We prove that the coeficient matrix of the system from this scheme is an M-matrix and that the approximate solution converges to the viscosity solution to the PIDE by showing that the scheme is consistent, monotone, and unconditionally stable. We also propose a Newton's iterative method coupled with a Fast Fourier Transform for the computation of the discretized integral term for solving the fully discretized system. Numerical results will be presented to demonstrate the convergence rates and usefulness of this method