Comparison of the analytical approximation formula and Newton's method for solving a class of nonlinear Black-Scholes parabolic equations

DOI10.1515/CMAM-2015-0035MaRDI QIDQ901413zbMATH OpenOpenAlexFDO

Authors Karol Ďuriš, Shih-Hau Tan, C. H. Lai, Daniel Ševčovič

Publication date 12 January 2016

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

Full work available at URL https://arxiv.org/abs/1511.05661

zbMATH Keywords

asymptotic formulaBlack-Scholes equationfinite difference methodNewton's methodnonlinear PDEoption pricing

Mathematics Subject Classification ID

Asymptotic expansions of solutions to PDEs (35C20) Nonlinear parabolic equations (35K55) PDEs in connection with game theory, economics, social and behavioral sciences (35Q91) Finite difference methods for initial value and initial-boundary value problems involving PDEs (65M06) Numerical methods (including Monte Carlo methods) (91G60)

Abstract: Market illiquidity, feedback effects, presence of transaction costs, risk from unprotected portfolio and other nonlinear effects in PDE based option pricing models can be described by solutions to the generalized Black-Scholes parabolic equation with a diffusion term nonlinearly depending on the option price itself. Different linearization techniques such as Newton's method and analytic asymptotic approximation formula are adopted and compared for a wide class of nonlinear Black-Scholes equations including, in particular, the market illiquidity model and the risk-adjusted pricing model. Accuracy and time complexity of both numerical methods are compared. Furthermore, market quotes data was used to calibrate model parameters.

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• Fast computational approach to the delta Greek of non-linear Black-Scholes equations
• Robust numerical algorithm to the European option with illiquid markets
• Newton-based solvers for nonlinear PDEs in finance
• Comparing of some sensitivities (Greeks) for nonlinear models of option pricing with market illiquidity
• An iterative algorithm for evaluating approximations to the optimal exercise boundary for a nonlinear Black-Scholes equation
• A Fréchet derivative‐based novel approach to option pricing models in illiquid markets
• An efficient numerical approach for solving three-dimensional Black-Scholes equation with stochastic volatility
• An investigation on nonlinear option pricing behaviours through a new Fréchet derivative-based quadrature approach

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