Numerical stability of a hybrid method for pricing options

DOI10.1142/S0219024919500365MaRDI QIDQ5207491zbMATH OpenWikidataFDO

Authors Maya Briani, Lucia Caramellino, Giulia Terenzi, Antonino Zanette

Publication date 2 January 2020

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

Full work available at URL https://arxiv.org/abs/1603.07225

zbMATH Keywords

European and American optionsfinite-differencejump-diffusion processnumerical stabilitystochastic volatilitytree methods

Mathematics Subject Classification ID

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

Abstract: We develop and study stability properties of a hybrid approximation of functionals of the Bates jump model with stochastic interest rate that uses a tree method in the direction of the volatility and the interest rate and a finite-difference approach in order to handle the underlying asset price process. We also propose hybrid simulations for the model, following a binomial tree in the direction of both the volatility and the interest rate, and a space-continuous approximation for the underlying asset price process coming from a Euler-Maruyama type scheme. We show that our methods allow to obtain efficient and accurate European and American option prices. Numerical experiments are provided, and show the reliability and the efficiency of the algorithms.

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Cited in

(4)

• Computing credit valuation adjustment solving coupled PIDEs in the Bates model
• Foreign exchange options on Heston-CIR model under Lévy process framework
• Convergence rate of Markov chains and hybrid numerical schemes to jump-diffusion with application to the Bates model
• Enhancing valuation of variable annuities in Lévy models with stochastic interest rate

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