Numerical solutions for jump-diffusions with regime switching
discretizationfinite differencesMarkov chainsmartingale problemnumerical methodsstochastic differential equationsweak convergence
Ordinary differential equations and systems with randomness (34F05) Generation, random and stochastic difference and differential equations (37H10) Integro-ordinary differential equations (45J05) Stochastic ordinary differential equations (aspects of stochastic analysis) (60H10) Continuous-time Markov processes on discrete state spaces (60J27) Diffusion processes (60J60) Monte Carlo methods (65C05) Probabilistic models, generic numerical methods in probability and statistics (65C20) Numerical solutions to stochastic differential and integral equations (65C30) Probabilistic methods, stochastic differential equations (65C99) Stability and convergence of numerical methods for ordinary differential equations (65L20) Numerical methods (including Monte Carlo methods) (91G60)
Consider stochastic differential equations with regime switching \[ dx(t) = f(\alpha(t),x(t)) dt + \sigma(\alpha(t),x(t)) \, dw(t) + dJ(\alpha,t) \] driven by an \(r\)-dimensional Brownian motion \(w\), where \(J(.,.)\) is a Markovian jump process, \(0 \leq t \leq T\), \(x(0)=x\), \(\alpha(0)=\alpha\) and \(\alpha(.)\) is a continuous-time Markov chain with finite state space. The main purpose of this paper is to propose a finite-difference numerical algorithm with constant step sizes for such systems. Under fairly simple conditions, it is proved that the algorithm provides weakly converging approximations to the desired limit by means of a martingale problem formulation and continuous time interpolation. This is done by first verifying the tightness of interpolated sequences of approximations and then identifying the limit process by examining the related martingale problem. Numerical experiments for several examples are carried out to demonstrate the performance of the algorithm.
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