Lie symmetry analysis of the Black-Scholes-Merton model for European options with stochastic volatility

DOI10.3390/MATH4020028zbMATH Open1358.91101arXiv1508.06797OpenAlexW1914940101MaRDI QIDQ515438FDOQ515438

Authors: Yong-Cai Geng, Sumit K. Garg 

Publication date: 16 March 2017

Published in: Mathematics (Search for Journal in Brave)

Abstract: We perform a classification of the Lie point symmetries for the Black--Scholes--Merton Model for European options with stochastic volatility, $sigma$, in which the last is defined by a stochastic differential equation with an Orstein--Uhlenbeck term. In this model, the value of the option is given by a linear (1 + 2) evolution partial differential equation in which the price of the option depends upon two independent variables, the value of the underlying asset, $S$, and a new variable, $y$. We find that for arbitrary functional form of the volatility, $sigma(y)$, the (1 + 2) evolution equation always admits two Lie point symmetries in addition to the automatic linear symmetry and the infinite number of solution symmetries. However, when $sigma(y)=sigm{a}_0$ and as the price of the option depends upon the second Brownian motion in which the volatility is defined, the (1 + 2) evolution is not reduced to the Black--Scholes--Merton Equation, the model admits five Lie point symmetries in addition to the linear symmetry and the infinite number of solution symmetries. We apply the zeroth-order invariants of the Lie symmetries and we reduce the (1 + 2) evolution equation to a linear second-order ordinary differential equation. Finally, we study two models of special interest, the Heston model and the Stein--Stein model.

Full work available at URL: https://arxiv.org/abs/1508.06797

Recommendations

• Symmetries of the Black-Scholes-Merton equation for European options
• scientific article; zbMATH DE number 7727662
• scientific article; zbMATH DE number 5944422
• Symmetry analysis of the option pricing model with dividend yield from financial markets
• Lie symmetries of \((1+2)\) nonautonomous evolution equations in financial mathematics

zbMATH Keywords

financial mathematicsstochastic volatilityLie point symmetriesBlack-Scholes-Merton equation

Mathematics Subject Classification ID

Derivative securities (option pricing, hedging, etc.) (91G20) PDEs in connection with game theory, economics, social and behavioral sciences (35Q91) Symmetries, invariants, etc. in context of PDEs (35B06) Applications of stochastic analysis (to PDEs, etc.) (60H30)

Cites Work

• The pricing of options and corporate liabilities
• A closed-form solution for options with stochastic volatility with applications to bond and currency options
• Stock price distributions with stochastic volatility: an analytic approach
• Lie symmetry analysis of differential equations in finance
• Group classification of a generalization of the Heath equation
• SOLVING THE ASIAN OPTION PDE USING LIE SYMMETRY METHODS
• Algebraic resolution of equations of the Black-Scholes type with arbitrary time-dependent parameters
• Lie point symmetries of a general class of PDEs: the heat equation
• An optimal system and group-invariant solutions of the Cox-Ingersoll-Ross pricing equation
• Algebraic properties of evolution partial differential equations modelling prices of commodities
• Simplifying the form of Lie groups admitted by a given differential equation
• Solving a partial differential equation associated with the pricing of power options with time-dependent parameters
• Lie symmetries of \((1+2)\) nonautonomous evolution equations in financial mathematics
• Algebraic solution of the Stein-Stein model for stochastic volatility
• Invariant solutions of the Black-Scholes equation
• A note on the integrability of the classical portfolio selection model

Cited In (13)

• Lie symmetry methods for local volatility models
• Lie symmetry analysis and similarity solutions for the Jimbo-Miwa equation and generalisations
• Title not available (Why is that?)
• Lie symmetry analysis of a first-order feedback model of option pricing
• Generalized symmetries and recursive operators of some diffusive equations
• Symmetry analysis of a model of stochastic volatility with time-dependent parameters
• Lie symmetry analysis and similarity solutions for the Camassa-Choi equations
• Symmetry analysis of the option pricing model with dividend yield from financial markets
• Title not available (Why is that?)
• Lie symmetry analysis, exact solutions, and conservation laws of variable-coefficients Boiti-Leon-Pempinelli equation
• Symmetry analysis of a model for the exercise of a barrier option
• Symmetries of the Black-Scholes-Merton equation for European options
• A Lie algebraic and numerical investigation of the Black-Scholes equation with Heston volatility model

Uses Software

• SYM

This page was built for publication: Lie symmetry analysis of the Black-Scholes-Merton model for European options with stochastic volatility

Report a bug (only for logged in users!)Click here to report a bug for this page (MaRDI item Q515438)