A fitted finite-volume method combined with the Lagrangian derivative for the weather option pricing model

DOI10.1515/CMAM-2015-0030MaRDI QIDQ901410zbMATH OpenOpenAlexFDO

Authors Shuhua Chang, Wenguang Tang

Publication date 12 January 2016

Published in Computational Methods in Applied Mathematics (Search for Journal in Brave)

Full work available at URL https://doi.org/10.1515/cmam-2015-0030

zbMATH Keywords

fitted finite volume methodjump diffusionLagrangean derivativesoption pricingpartial differential equation

Mathematics Subject Classification ID

PDEs in connection with statistics (35Q62) PDEs in connection with game theory, economics, social and behavioral sciences (35Q91) Brownian motion (60J65) Numerical methods for variational inequalities and related problems (65K15) Financial applications of other theories (91G80)

Review text

The authors develop a new weather option pricing model on a stochastic underlying temperature following a mean-reverting Brownian motion. In this way, a two-dimensional partial differential equation for the pricing model is obtained. This was possible under the assumption of mean-self-financing, by means of the hedging technique with a correlated asset following a geometric Brownian motion with a jump diffusion process. The method proposed for the numerical solution of the resulting partial differential equation is a combination of a fitted finite-volume method and the Lagrangian derivative. Also, the authors approach the monotonicity, stability, and convergence of the discrete scheme. Finally, some numerical examples are provided to analyze the effects of parameters in the pricing model on the prices of options.

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