The Euler-Maruyama approximations for the CEV model

DOI10.3934/DCDSB.2011.16.1MaRDI QIDQ553454zbMATH OpenOpenAlexWikidataFDO

Authors Vyacheslav Abramov, Fima Klebaner, R. Liptser

Publication date 27 July 2011

Published in Discrete and Continuous Dynamical Systems. Series B (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/1005.0728

zbMATH Keywords

absorptionCEV modelconstant elasticity of variance modelEuler Maruyama algorithmnon-Lipschitz diffusionnumerical exampleruin probabilitySkorohod metricweak convergence

Mathematics Subject Classification ID

Random integral equations (45R05) Stochastic integral equations (60H20) Computational methods for stochastic equations (aspects of stochastic analysis) (60H35) Numerical solutions to stochastic differential and integral equations (65C30) Numerical methods (including Monte Carlo methods) (91G60)

Abstract: The CEV model is given by the stochastic differential equation $X_t=X_0+in{t}_0^{t}mu{X}_{s}ds+in{t}_0^{t}sigma(X_s^{+}{)}^{p}d{W}_s$, $frac12lep<1$. It features a non-Lipschitz diffusion coefficient and gets absorbed at zero with a positive probability. We show the weak convergence of Euler-Maruyama approximations $X_t^n$ to the process $X_t$, $0letleT$, in the Skorokhod metric. We give a new approximation by continuous processes which allows to relax some technical conditions in the proof of weak convergence in cite{HZa} done in terms of discrete time martingale problem. We calculate ruin probabilities as an example of such approximation. We establish that the ruin probability evaluated by simulations is not guaranteed to converge to the theoretical one, because the point zero is a discontinuity point of the limiting distribution. To establish such convergence we use the Levy metric, and also confirm the convergence numerically. Although the result is given for the specific model, our method works in a more general case of non-Lipschitz diffusion with absorbtion.

Review text

The constant elasticity of variance (CEV) model is given by the Ito's equation \[ X_t=X_0+\int_{0}^{t}\mu X_sds+ \int_{0}^{t}\sigma (X_0^+)^p dW_s, \] where \(\frac{1}{2}\leq p<1, \sigma >0 \), of which the solution describes a singular diffusion process \(X_t\) with non-Lipschitz diffusion coefficient, absorbed at zero with positive probability. In the present paper, it is shown that the Euler Maruyama approximation converges weakly to this diffusion in Skorohod metric on the time interval \([0,T]\), and the related ruin probability is also approximated by this scheme. A numerical simulation is provided.

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Cited in

(10)

• Approximating explicitly the mean-reverting CEV process
• The log-asset dynamic with Euler-Maruyama scheme under Wishart processes
• The sub-fractional CEV model
• Classes of elementary function solutions to the CEV model I
• Simulation of the CEV process and the local martingale property
• The Euler-Maruyama approximation for the absorption time of the CEV diffusion
• On strong causal binomial approximation for stochastic processes
• A transformed jump-adapted backward Euler method for jump-extended CIR and CEV models
• Weak approximation of CKLS and CEV processes by discrete random variables
• Approximating exit times of continuous Markov processes

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