A finite element discretization method for option pricing with the Bates model

DOI10.1007/BF03322591MaRDI QIDQ435146zbMATH OpenOpenAlexFDO

Authors E. Miglio, Carlo Sgarra

Publication date 11 July 2012

Published in S\(\vec{\text{e}}\)MA Journal (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/0812.3083

Mathematics Subject Classification ID

Derivative securities (option pricing, hedging, etc.) (91G20) Numerical methods (including Monte Carlo methods) (91G60) Finite element, Rayleigh-Ritz and Galerkin methods for initial value and initial-boundary value problems involving PDEs (65M60)

Abstract: In the present paper we present a finite element approach for option pricing in the framework of a well-known stochastic volatility model with jumps, the Bates model. In this model the asset log-returns are assumed to follow a jump-diffusion model where the jump component consists of a Levy process of compound Poisson type, while the volatility behavior is described by a stochastic differential equation of CIR type, with a mean-reverting drift term and a diffusion component correlated with that of the log-returns. Like in all the Levy models, the option pricing problem can be formulated in terms of an integro-differential equation: for the Bates model the unknown F(S, V, t) (the option price) of the pricing equation depends on three independent variables and the differential operator part turns out to be of parabolic kind, while the nonlocal integral operator is calculated with respect to the Levy measure of the jumps. In this paper we will present a variational formulation of the problem suitable for a finite element approach. The numerical results obtained for european options will be compared with those obtained with different methods.

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Cited in

(10)

• Option pricing for a stochastic volatility jump-diffusion model
• A finite elements approach for spread contract valuation via associated two-dimensional PIDE
• A NEW FINITE ELEMENT METHOD FOR PRICING OF BOND OPTIONS UNDER TIME INHOMOGENEOUS AFFINE TERM STRUCTURE MODELS OF INTEREST RATES
• Adaptive finite differences and IMEX time-stepping to price options under Bates model
• Fast numerical pricing of barrier options under stochastic volatility and jumps
• Efficient hedging in Bates model using high-order compact finite differences
• European option valuation under the Bates PIDE in finance: a numerical implementation of the Gaussian scheme
• The evaluation of American options in a stochastic volatility model with jumps: an efficient finite element approach
• Real options pricing by the finite element method
• A variable step‐size extrapolated Crank–Nicolson method for option pricing under stochastic volatility model with jump

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