Numerical smoothing with hierarchical adaptive sparse grids and quasi-Monte Carlo methods for efficient option pricing
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adaptive sparse grid quadratureBrownian bridgedistribution functionsGreeksMonte Carlonumerical smoothingoption pricingquasi-Monte CarloRichardson extrapolationrisk estimation
Monte Carlo methods (65C05) Numerical integration (65D30) Numerical quadrature and cubature formulas (65D32) Numerical approximation of high-dimensional functions; sparse grids (65D40) Complexity and performance of numerical algorithms (65Y20) Derivative securities (option pricing, hedging, etc.) (91G20) Numerical methods (including Monte Carlo methods) (91G60)
Abstract: When approximating the expectations of a functional of a solution to a stochastic differential equation, the numerical performance of deterministic quadrature methods, such as sparse grid quadrature and quasi-Monte Carlo (QMC) methods, may critically depend on the regularity of the integrand. To overcome this issue and improve the regularity structure of the problem, we consider cases in which analytic smoothing (bias-free mollification) cannot be performed and introduce a novel numerical smoothing approach by combining a root-finding method with a one-dimensional numerical integration with respect to a single well-chosen variable. We prove that, under appropriate conditions, the resulting function of the remaining variables is highly smooth, potentially affording the improved efficiency of adaptive sparse grid quadrature (ASGQ) and QMC methods, particularly when combined with hierarchical transformations (ie., the Brownian bridge and Richardson extrapolation on the weak error). This approach facilitates the effective treatment of high dimensionality. Our study is motivated by option pricing problems, focusing on dynamics where the discretization of the asset price is necessary. Based on our analysis and numerical experiments, we demonstrate the advantages of combining numerical smoothing with the ASGQ and QMC methods over these methods without smoothing and the Monte Carlo approach. Finally, our approach is generic and can be applied to solve a broad class of problems, particularly approximating distribution functions, computing financial Greeks, and estimating risk quantities.
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Cited in
(7)- Smoothing the payoff for efficient computation of Basket option prices
- Efficient Computation of Option Prices and Greeks by Quasi--Monte Carlo Method with Smoothing and Dimension Reduction
- Multilevel Monte Carlo with numerical smoothing for robust and efficient computation of probabilities and densities
- Error analysis of randomized quasi-Monte Carlo: non-asymptotic error bound, importance sampling and application to linear elliptic PDEs with lognormal coefficients
- Pricing and hedging autocallable products by Markov chain approximation
- Density estimation for elliptic PDE with random input by preintegration and quasi-Monte Carlo methods
- Efficient risk estimation for the credit valuation adjustment
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