PRICING AMERICAN OPTIONS WITH THE RUNGE–KUTTA–LEGENDRE FINITE DIFFERENCE SCHEME

DOI10.1142/S0219024921500187zbMATH Open1470.91327arXiv2106.12049OpenAlexW3157534343MaRDI QIDQ5010071FDOQ5010071

Authors: Fabien Le Floc'h 

Publication date: 24 August 2021

Published in: International Journal of Theoretical and Applied Finance (Search for Journal in Brave)

Abstract: This paper presents the Runge-Kutta-Legendre finite difference scheme, allowing for an additional shift in its polynomial representation. A short presentation of the stability region, comparatively to the Runge-Kutta-Chebyshev scheme follows. We then explore the problem of pricing American options with the Runge-Kutta-Legendre scheme under the one factor Black-Scholes and the two factor Heston stochastic volatility models, as well as the pricing of butterfly spread and digital options under the uncertain volatility model, where a Hamilton-Jacobi-Bellman partial differential equation needs to be solved. We explore the order of convergence in these problems, as well as the option greeks stability, compared to the literature and popular schemes such as Crank-Nicolson, with Rannacher time-stepping.

Full work available at URL: https://arxiv.org/abs/2106.12049

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zbMATH Keywords

finite difference methodpricingstochastic volatilityAmerican optionsquantitative financeRunge-Kutta-Chebyshevuncertain volatilityRunge-Kutta-Legendre

Mathematics Subject Classification ID

Derivative securities (option pricing, hedging, etc.) (91G20) Numerical methods (including Monte Carlo methods) (91G60) Stopping times; optimal stopping problems; gambling theory (60G40) Finite difference methods for initial value and initial-boundary value problems involving PDEs (65M06)

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Cited In (2)

• An adaptive and explicit fourth order Runge-Kutta-Fehlberg method coupled with compact finite differencing for pricing American put options
• Stabilized explicit Runge-Kutta methods for multi-asset American options

Uses Software

• RKC

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