A fitted finite-volume method combined with the Lagrangian derivative for the weather option pricing model (Q901410)

The authors develop a new weather option pricing model on a stochastic underlying temperature following a mean-reverting Brownian motion. In this way, a two-dimensional partial differential equation for the pricing model is obtained. This was possible under the assumption of mean-self-financing, by means of the hedging technique with a correlated asset following a geometric Brownian motion with a jump diffusion process. The method proposed for the numerical solution of the resulting partial differential equation is a combination of a fitted finite-volume method and the Lagrangian derivative. Also, the authors approach the monotonicity, stability, and convergence of the discrete scheme. Finally, some numerical examples are provided to analyze the effects of parameters in the pricing model on the prices of options.