Journal of Computational Finance
ISSN:
1460-1559 (print)
1755-2850 (online)
Editor-in-chief: Christoph Reisinger
Convergence remedies for non-smooth payoffs in option pricing
David M. Pooley, Kenneth R.Vetzal, Peter A. Forsyth
Abstract
ABSTRACT
Discontinuities in the payoff function (or its derivatives) can cause inaccuracies for numerical schemes when financial contracts are priced. In particular, large errors may occur in the estimation of the hedging parameters. Three methods of dealing with discontinuities are discussed in this article: averaging the initial data, shifting the grid, and a projection method. By themselves, these techniques are not sufficient to restore expected behavior. However, when combined with a special time-stepping method, high accuracy is achieved. Examples are provided for one- and two-factor option pricing problems.
Copyright Infopro Digital Limited. All rights reserved.
As outlined in our terms and conditions, https://www.infopro-digital.com/terms-and-conditions/subscriptions/ (point 2.4), printing is limited to a single copy.
If you would like to purchase additional rights please email info@risk.net
Copyright Infopro Digital Limited. All rights reserved.
You may share this content using our article tools. As outlined in our terms and conditions, https://www.infopro-digital.com/terms-and-conditions/subscriptions/ (clause 2.4), an Authorised User may only make one copy of the materials for their own personal use. You must also comply with the restrictions in clause 2.5.
If you would like to purchase additional rights please email info@risk.net
