Fluctuation identities with continuous monitoring and their application to the pricing of barrier options
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Publication:724078
DOI10.1016/J.EJOR.2018.04.016zbMATH Open1403.91350arXiv1712.00077OpenAlexW2772008458MaRDI QIDQ724078FDOQ724078
Authors: Carolyn E. Phelan, Daniele Marazzina, Gianluca Fusai, Guido Germano 
Publication date: 25 July 2018
Published in: European Journal of Operational Research (Search for Journal in Brave)
Abstract: We present a numerical scheme to calculate fluctuation identities for exponential L'evy processes in the continuous monitoring case. This includes the Spitzer identities for touching a single upper or lower barrier, and the more difficult case of the two-barriers exit problem. These identities are given in the Fourier-Laplace domain and require numerical inverse transforms. Thus we cover a gap in the literature that has mainly studied the discrete monitoring case; indeed, there are no existing numerical methods that deal with the continuous case. As a motivating application we price continuously monitored barrier options with the underlying asset modelled by an exponential L'evy process. We perform a detailed error analysis of the method and develop error bounds to show how the performance is limited by the truncation error of the sinc-based fast Hilbert transform used for the Wiener-Hopf factorisation. By comparing the results for our new technique with those for the discretely monitored case (which is in the Fourier- domain) as the monitoring time step approaches zero, we show that the error convergence with continuous monitoring represents a limit for the discretely monitored scheme.
Full work available at URL: https://arxiv.org/abs/1712.00077
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Derivative securities (option pricing, hedging, etc.) (91G20) Numerical methods (including Monte Carlo methods) (91G60)
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- Closed-form option pricing for exponential Lévy models: a residue approach
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- A data-driven framework for consistent financial valuation and risk measurement
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