Closed-form asymptotics and numerical approximations of 1D parabolic equations with applications to option pricing

DOI10.1137/100796832MaRDI QIDQ5388689zbMATH OpenOpenAlexFDO

Authors Wen Cheng, Nick Costanzino, Anna L. Mazzucato, Victor Nistor, John C. Liechty

Publication date 19 April 2012

Published in SIAM Journal on Financial Mathematics (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/0910.2309

zbMATH Keywords

closed-form solutionDyson-Taylor commutatorGreen's functionlocal volatility

Mathematics Subject Classification ID

Fundamental solutions to PDEs (35A08) Solutions to PDEs in closed form (35C05) Heat kernel (35K08) Second-order parabolic equations (35K10) Degenerate parabolic equations (35K65) Fokker-Planck equations (35Q84) Derivative securities (option pricing, hedging, etc.) (91G20) Numerical methods (including Monte Carlo methods) (91G60) Financial applications of other theories (91G80)

Abstract: We obtain new closed-form pricing formulas for contingent claims when the asset follows a Dupire-type local volatility model. To obtain the formulas we use the Dyson-Taylor commutator method that we have recently developed in [5, 6, 8] for short-time asymptotic expansions of heat kernels, and obtain a family of general closed-form approximate solutions for both the pricing kernel and derivative price. A bootstrap scheme allows us to extend our method to large time. We also perform analytic as well as a numerical error analysis, and compare our results to other known methods.

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(12)

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• A semigroup approach to generalized Black-Scholes type equations in incomplete markets
• Short Maturity Asian Options in Local Volatility Models
• A volatility-of-volatility expansion of the option prices in the SABR stochastic volatility model
• Implied Volatility from Local Volatility: A Path Integral Approach
• SHORT MATURITY ASIAN OPTIONS FOR THE CEV MODEL
• Approximate solutions to second order parabolic equations. I: Analytic estimates
• Analytical expansions for parabolic equations
• The heat-kernel most-likely-path approximation
• Approximate solutions to second-order parabolic equations: evolution systems and discretization
• SHORT-MATURITY ASYMPTOTICS FOR OPTION PRICES WITH INTEREST RATE EFFECTS
• Some asymptotics for short maturity Asian options

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