Singular Fourier-Padé series expansion of European option prices

DOI10.1080/14697688.2017.1414952MaRDI QIDQ4554487zbMATH OpenOpenAlexFDO

Authors Tat Lung Chan (Ron)

Publication date 14 November 2018

Published in Quantitative Finance (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/1706.06709

zbMATH Keywords

affine processesLévy processesEuropean-type optionssingular Fourier-Padé series

Mathematics Subject Classification ID

Processes with independent increments; Lévy processes (60G51) Derivative securities (option pricing, hedging, etc.) (91G20)

Abstract: We apply a new numerical method, the singular Fourier-Pad'e (SFP) method invented by Driscoll and Fornberg (2001, 2011), to price European-type options in L'evy and affine processes. The motivation behind this application is to reduce the inefficiency of current Fourier techniques when they are used to approximate piecewise continuous (non-smooth) probability density functions. When techniques such as fast Fourier transforms and Fourier series are applied to price and hedge options with non-smooth probability density functions, they cause the Gibbs phenomenon, accordingly, the techniques converge slowly for density functions with jumps in value or derivatives. This seriously adversely affects the efficiency and accuracy of these techniques. In this paper, we derive pricing formulae and their option Greeks using the SFP method to resolve the Gibbs phenomenon and restore the global spectral convergence rate. Moreover, we show that our method requires a small number of terms to yield fast error convergence, and it is able to accurately price any European-type option deep in/out of the money and with very long/short maturities. Furthermore, we conduct an error-bound analysis of the SFP method in option pricing. This new method performs favourably in numerical experiments compared with existing techniques.

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Cited in

(6)

• Pricing European-type, early-exercise and discrete barrier options using an algorithm for the convolution of Legendre series
• Uniform asymptotic expansions for pricing European options
• Fourier Cosine Expansions and Put–Call Relations for Bermudan Options
• The SINC way: a fast and accurate approach to Fourier pricing
• An SFP-FCC method for pricing and hedging early-exercise options under Lévy processes
• Hermite polynomial based expansion of European option prices

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Uses Software

• BENCHOP

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