Error analysis of finite difference scheme for American option pricing under regime-switching with jumps (Q6049312): Difference between revisions

This paper proposes an efficient numerical method for evaluating American options under regime-switching jump-diffusion models (Merton's and Kou's models). By the relation of optimal exercise boundaries among several options, a simplified model defined on a bounded domain is first presented to approximate the original model defined on an unbounded domain. Then a composite trapezoidal formula is applied, which guarantees that the integral discretized matrix is a Toeplitz matrix. More precisely, a finite difference method are applied to discretize the simplified model to be an LCP in finite dimensional space. Simultaneously, the authors analyze the related properties of the discretization scheme and estimate the convergence error. Finally, several numerical simulations are carried out to verify the proposed method's theoretical analysis and efficiency.