Optimal convergence rate of the explicit finite difference scheme for American option valuation (Q2390004): Difference between revisions
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English | Optimal convergence rate of the explicit finite difference scheme for American option valuation |
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Optimal convergence rate of the explicit finite difference scheme for American option valuation (English)
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20 July 2009
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An optimal convergence rate \(\mathcal{O}(\Delta x)\) for an explicit finite difference scheme for a variational inequality problem is obtained under the stability condition \(\frac{\sigma^2 \Delta t}{\Delta x^2} \leq 1\) using completely PDE methods without using probability theory. As a corollary, a binomial tree scheme of an American put option (where \(\frac{\sigma^2 \Delta t}{\Delta x^2} = 1 \) is convergent unconditionally with the rate \(\mathcal{O}((\Delta t)^{\frac{1}{2}})\). The author's result includes the BTM as a special case.
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American put option
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explicit finite difference scheme
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binomial tree method
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