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Pricing Options under Jump-Diffusion Models by Adaptive Radial Basic Functions


Reference:

Chan, R., 2010. Pricing Options under Jump-Diffusion Models by Adaptive Radial Basic Functions. Working Paper. Bath, U. K.: Department of Economics, University of Bath. (Bath Economics Research Working Papers; 06/10)

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    Official URL:

    http://www.bath.ac.uk/economics/research/working-papers

    Abstract

    The aim of this paper is to show that option prices in jump-diffusion models can be computed using meshless methods based on Radial Basis Function (RBF) interpolation instead of traditional mesh-based methods like Finite Differences (FDM) or Finite Elements (FEM). The RBF technique is demonstrated by solving the partial integro-differential equation for American and European options on non-dividend-paying stocks in the Merton jump-diffusion model, using the Inverse Multiquadric Radial Basis Function (IMQ). The method can in principle be extended to Levy-models. Moreover, an adaptive method is proposed to tackle the accuracy problem caused by a singularity in the initial condition so that the accuracy in option pricing in particular for small time to maturity can be improved.

    Details

    Item Type Reports/Papers (Working Paper)
    CreatorsChan, R.
    Uncontrolled Keywordsthe merton jump-diffusions model, singularity, option pricing, adaptive method, radial basis function, levy processes, parabolic partial integro-differential equations
    DepartmentsFaculty of Humanities & Social Sciences > Economics
    Research CentresBath Economics Research
    StatusUnpublished
    ID Code19329
    Additional InformationID number: 06/10

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