Application of operator splitting methods in finance

DOI10.1007/978-3-319-41589-5_16zbMATH Open1371.91193arXiv1504.01022OpenAlexW1606767626MaRDI QIDQ5350488FDOQ5350488

Authors: Jari Toivanen, Karel J. in 't Hout 

Publication date: 1 September 2017

Published in: Splitting Methods in Communication, Imaging, Science, and Engineering (Search for Journal in Brave)

Abstract: Financial derivatives pricing aims to find the fair value of a financial contract on an underlying asset. Here we consider option pricing in the partial differential equations framework. The contemporary models lead to one-dimensional or multidimensional parabolic problems of the convection-diffusion type and generalizations thereof. An overview of various operator splitting methods is presented for the efficient numerical solution of these problems. Splitting schemes of the Alternating Direction Implicit (ADI) type are discussed for multidimensional problems, e.g. given by stochastic volatility (SV) models. For jump models Implicit-Explicit (IMEX) methods are considered which efficiently treat the nonlocal jump operator. For American options an easy-to-implement operator splitting method is described for the resulting linear complementarity problems. Numerical experiments are presented to illustrate the actual stability and convergence of the splitting schemes. Here European and American put options are considered under four asset price models: the classical Black-Scholes model, the Merton jump-diffusion model, the Heston SV model, and the Bates SV model with jumps.

Full work available at URL: https://arxiv.org/abs/1504.01022

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Mathematics Subject Classification ID

Derivative securities (option pricing, hedging, etc.) (91G20) Numerical methods (including Monte Carlo methods) (91G60) Finite difference methods for initial value and initial-boundary value problems involving PDEs (65M06)

Cited In (19)

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• ADI schemes for valuing European options under the Bates model
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• On the pricing of multi-asset options under jump-diffusion processes using meshfree moving least-squares approximation

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