On the regularity of the free boundary in the parabolic obstacle problem. Application to American options (Q2498794)

The author considers the one-dimensional parabolic obstacle problem with variable coefficients \[ Lu=f(x,t)\chi_{\{u>0\}},\quad u(x,t)\geq 0, \] \noindent where \(L\) is the parabolic operator \[ Lu=a(x,t){{\partial^2 u }\over{\partial x^2}}+b(x,t){{\partial u }\over{\partial x}}+c(x,t)u-{{\partial u }\over{\partial t}}. \] The functions \(a, b, c, f\) are assumed to be Hölder continuous and \(a, f\) are assumed to be positive functions. The main result of the paper is that the set of regular points is locally a \(C^{1/2}\)-graph and that the subset of the set of singular points for which \[ \liminf_{r\rightarrow 0} {{| \{u=0\}\cap Q_r(P)| }\over{| Q_r(P)| }}=0, \] \(Q_r(P)\) is the parabolic cylinder, is locally contained in a \(C^{1/2}\)-graph. The above results are then applied to prove that the exercise boundary of the American put and call options are Hölder continuous with exponent \(1/2\) in time.