A pseudospectral method for option pricing with transaction costs under exponential utility (Q2029418)

The following dynamic model is known on the assumption that an investor holds an amount \(\overline X(t)\) in the bank account and \(\overline y(t)\) shares of a certain stock \(\overline S(t)\) \[ \begin{array}{l} d\overline X(t)=r \overline X(t)dt - (1+\lambda)\overline S(t)d\overline L(t)+(1-\mu)\overline S(t)d\overline M(t),\\ d\overline y(t)=d \overline L(t)-d\overline M(t),\\ d\overline S(t)=\overline S(t) \alpha dt+\overline S(t) \sigma dz_t,\\ \end{array} \] where \(r\) is the constant risk-free rate, \(\alpha\) is the constant expected rate of return of the stock, \(\sigma>0\) is the constant volatility of the stock and \(z_t\) is the standard Brownian motion. \(\overline L(t)\) and \(\overline M(t)\) are adapted, right-continuous, nonnegative and nondecreasing processes. The authors propose two changes of variables that reduce the impact of the exponential growth and a Fourier pseudospectral method to solve the resulting nonlinear equation. Numerical analysis of the stability of the method is included.