American put option with regime‐switching volatility (finite time horizon)—Variational inequality approach

We study the fair price of American put option with regime‐switching volatility. Assuming that volatility σ(t) takes two different values σ₁ and σ₂, applying Δ hedging technique we obtain a system of evolutionary variational inequalities, which possesses two free boundaries (optimal exercise boundaries). The following are the main results of this paper.

• 1. Two free boundaries are monotonic and infinitely differentiable.
• 2. The optimal exercise boundary of American put option with regime‐switching volatility in the bearish (or bullish) market is smaller (or higher) than the one of standard American put option. And the price of American put option with regime‐switching volatility in the bearish (or bullish) market is higher (or smaller) than the one of standard American put option.
• 3. The solution of problem (1) is unique.

These results are original in the option pricing with regime‐switching volatility, the proof is technical. Copyright © 2008 John Wiley & Sons, Ltd.     

A variational inequality arising from American installment call options pricing

In this paper we consider a parabolic variational inequality with two free boundaries arising from American continuous-installment call options pricing. We prove the existence and uniqueness of the solution to the problem. Moreover, we obtain the monotonicity and smoothness of two free boundaries and show its numerical solution by the binomial method.     

A variational inequality arising from European option pricing with transaction costs

In this paper we present a method which can transform a variational inequality with gradient constraints into a usual two obstacles problem in one dimensional case.The prototype of the problem is a parabolic variational inequality with the constraints of two first order differential inequalities arising from a two-dimensional model of European call option pricing with transaction costs.We obtain the monotonicity and smoothness of two free boundaries.     

Partial differential integral equation model for pricing American option under multi state regime switching with jumps

In this paper, we consider a two dimensional partial differential integral equation (PDIE) model for pricing American option. A nonlinear rationality parameter function for two asset problems is introduced to deal with the free boundary. The rationality parameter function is added in the PDIEs used for pricing American option problems under multi-state regime switching with jumps. The resulting two dimensional nonlinear system of PDIE is then numerically solved. Based on real poles rational approximation, a strongly stable highly efficient and reliable method is developed to solve such complicated systems of PIDEs. The method is build in a predictor corrector style which makes it linearly implicit, therefore, avoids solving nonlinear systems of equations at each time step in all regimes. The method is seen to maintain the stability and convergence for large jump sizes and high volatility in each regime. The impact of regime switching on option prices corresponding to different values interest rate, volatility, and rationality parameter is computed, illustrated by graphs and given in the tables. Convergence results in each regime are presented and time evolution graphs are given to show the effectiveness and reliability of the method.     

Parabolic variational inequality with parameter and gradient constraints

This paper concerns a singular control problem whose value function is governed by a time-dependent HJB equation with gradient constraints. The method is to transform a two-dimensional parabolic variational inequality with gradient constraints into a double obstacle problem with parameter involving two free boundaries that correspond to the investment and disinvestment policies. Moreover we analyze the behaviors of the free boundary surfaces. The main difficulties are to show the free boundary surfaces to be smooth with respect to time and to find the properties of free boundaries with respect to parameter.     

Free boundary problem concerning pricing convertible bond

In this paper, we consider some behaviors of the optimal conversion boundaries (i.e. free boundaries) of American‐style convertible bond with finite horizon in some case. The bond's holder may convert it into the stock of its issued firm at any time before maturity, and the firm may call it at any time before maturity. Its pricing model is a parabolic variational inequality, in which the fundamental variables are time and the stock price of the bond's issuer. We achieve some properties of the free boundary, besides the existence and uniqueness of the solution of the variational inequality, such as: the monotonicity, the boundedness, smoothness and its starting point. Moreover, we analyze the relationship between the free boundary and the parameters in the problem, as well as, obtain the critical condition where the free boundary is a constant independent of time. Copyright © 2011 John Wiley & Sons, Ltd.     

Two Efficient Parameterized Boundaries for Veneers Asian Option Pricing PDE

In this paper, we derive two general parameterized boundaries of finite difference scheme for Ve?e???s PDE which is used to price both fixed and floating strike Asian options. Using these two boundaries, we can deal with all kinds of situations, especially, some extreme cases, like overhigh volatility, very small volatility, etc, under which the Asian option is usually mispriced in many existing numerical methods. Numerical results show that our boundaries are pretty efficient.     

Hamiltonian long‐wave expansions for free surfaces and interfaces

The theory of internal waves between two bodies of immiscible fluid is important both for its interest to ocean engineering and as a source of numerous interesting mathematical model equations that exhibit nonlinearity and dispersion. In this paper we derive a Hamiltonian formulation of the problem of a dynamic free interface (with rigid lid upper boundary conditions), and of a free surface and a free interface, this latter situation occurring more commonly in experiment and in nature. From the formulation, we develop a Hamiltonian perturbation theory for the long‐wave limits, and we carry out a systematic analysis of the principal long‐wave scaling regimes. This analysis provides a uniform treatment of the classical works of Peters and Stoker (28), Benjamin (3, 4), Ono (26), and many others. Our considerations include the Boussinesq and Korteweg–de Vries (KdV) regimes over finite‐depth fluids, the Benjamin‐Ono regimes in the situation in which one fluid layer is infinitely deep, and the intermediate long‐wave regimes. In addition, we describe a novel class of scaling regimes of the problem, in which the amplitude of the interface disturbance is of the same order as the mean fluid depth, and the characteristic small parameter corresponds to the slope of the interface. Our principal results are that we highlight the discrepancies between the case of rigid lid and of free surface upper boundary conditions, which in some circumstances can be significant. Motivated by the recent results of Choi and Camassa (6, 7), we also derive novel systems of nonlinear dispersive long‐wave equations in the large‐amplitude, small‐slope regime. Our formulation of the dynamical free‐surface, free‐interface problem is shown to be very effective for perturbation calculations; in addition, it holds promise as a basis for numerical simulations. © 2005 Wiley Periodicals, Inc.     

Flächen Beschränkter Mittlerer Krümmung in Einer Dreidimensionalen Riemannschen Mannigfaltigkeit

In recent papers HILDEBRANDT [11] and HARTH [5] proved the existence of solutions of the problem of Plateau for surfaces of bounded mean curvature with fixed and free boundaries in E³ and for minimal surfaces with free boundaries in a Riemannian manifold, respectively. Here their methods will be combined to solve the problem of Plateau for surfaces of bounded mean curvature in a Riemannian manifold. This will be done for fixed and free boundaries. Moreover, isoperimetric inequalities for the solutions will be given.

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Diese Arbeit beruht auf meiner Dissertation (Mainz 1971)     

On an elliptic-parabolic MEMS model with two free boundaries

We discuss an evolution free boundary problem of mixed type with two free boundaries modeling an idealized electrostatically actuated MEMS device. While the electric potential is the solution of an elliptic equation, the dynamics of the membranes’ displacement is modeled by two parabolic equations. It is shown that the model is locally well-posed in time and that solutions exist globally for small source voltages whereas non-existence holds for large voltage values. Moreover, our model possesses a steady state solution that is asymptotically stable. Finally, we show that in the vanishing aspect ratio limit, solutions of the model converge toward solutions of the associated small aspect ratio problem.     

Global existence and blow-up of solutions of nonlocal diffusion problems with free boundaries

In this paper, we investigate some nonlocal diffusion problems with free boundaries. We first give the existence and uniqueness of local solution by the ODE basic theory and the contraction mapping principle. Then we provide a complete classification for the global existence and finite time blow-up of solutions. Moreover, estimates of blow-up rate and blow-up time are also obtained for the blow-up solution.     

On the asymptotic free boundary for the American put option problem

In practical work with American put options, it is important to be able to know when to exercise the option, and when not to do so. In computer simulation based on the standard theory of geometric Brownian motion for simulating stock price movements, this problem is fairly easy to handle for options with a short lifespan, by analyzing binomial trees. It is considerably more challenging to make the decision for American put options with long lifespan. In order to provide a satisfactory analysis, we look at the corresponding free boundary problem, and show that the free boundary—which is the curve that separates the two decisions, to exercise or not to—has an asymptotic expansion, where the coefficient of the main term is expressed as an integral in terms of the free boundary. This raises the perspective that one could use numerical simulation to approximate the integral and thus get an effective way to make correct decisions for long life options.     

Stability of a Mach configuration

We prove the stability of a Mach configuration, which occurs in shock reflection off an obstacle or shock interaction in compressible flow. The compressible flow is described by a full, steady Euler system of gas dynamics. The unperturbed Mach configuration is composed of three straight shock lines and a slip line carrying contact discontinuity. Among four regions divided by these four lines in the neighborhood of the intersection, two are supersonic regions, and other two are subsonic regions. We prove that if the constant states in the supersonic regions are slightly perturbed, then the structure of the whole configuration holds, while the other two shock fronts and the slip line, as well as the flow field in the subsonic regions, are also slightly perturbed. Such a conclusion asserts the existence and stability of the general Mach configuration in shock theory. In order to prove the result, we reduce the problem to a free boundary value problem, where two unknown shock fronts are free boundaries, while the slip line is transformed to a fixed line by a Lagrange transformation. In the region where the solution is to be determined, we have to deal with an elliptic‐hyperbolic composed system. By decoupling this system and combining the technique for both hyperbolic equations and elliptic equations, we establish the required estimates, which are crucial in the proof of the existence of a solution to the free boundary value problem. © 2005 Wiley Periodicals, Inc.     

Pricing of perpetual American and Bermudan options by binomial tree method

In this paper, we consider the binomial tree method for pricing perpetual American and perpetual Bermudan options. The closed form solutions of these discrete models are solved. Explicit formulas for the optimal exercise boundary of the perpetual American option is obtained. A nonlinear equation that is satisfied by the optimal exercise boundaries of the perpetual Bermudan option is found.      

Two-phase Stefan problem for generalized heat equation with nonlinear thermal coefficients

In this article we study a mathematical model of the heat transfer in semi infinite material with a variable cross section, when the radial component of the temperature gradient can be neglected in comparison with the axial component. In particular, the temperature distribution in liquid and solid phases of such kind of body can be modeled by Stefan problem for the generalized heat equation. The method of solution is based on similarity principle, which enables us to reduce generalized heat equation to nonlinear ordinary differential equation. Moreover, we determine temperature solution for two phases and free boundaries which describe the position of boiling and melting interfaces. Existence and uniqueness of the similarity type solution is provided by using the fixed point Banach theorem.     

A Family of Maximum Entropy Densities Matching Call Option Prices

Abstract

We investigate the position of the Buchen–Kelly density (Peter W. Buchen and Michael Kelly. The maximum entropy distribution of an asset inferred from option prices. Journal of Financial and Quantitative Analysis, 31(1), 143–159, March 1996.) in the family of entropy maximizing densities from Neri and Schneider (Maximum entropy distributions inferred from option portfolios on an asset. Finance and Stochastics, 16(2), 293–318, April 2012.), which all match European call option prices for a given maturity observed in the market. Using the Legendre transform, which links the entropy function and the cumulant generating function, we show that it is both the unique continuous density in this family and the one with the greatest entropy. We present a fast root-finding algorithm that can be used to calculate the Buchen–Kelly density and give upper boundaries for three different discrepancies that can be used as convergence criteria. Given the call prices, arbitrage-free digital prices at the same strikes can only move within upper and lower boundaries given by left and right call spreads. As the number of call prices increases, these bounds become tighter, and we give two examples where the densities converge to the Buchen–Kelly density in the sense of relative entropy. The method presented here can also be used to interpolate between call option prices, and we compare it to a method proposed by Kahalé (An arbitrage-free interpolation of volatilities. Risk, 17(5), 102–106, May 2004). Orozco Rodriguez and Santosa (Estimation of asset distributions from option prices: Analysis and regularization. SIAM Journal on Financial Mathematics, 3(1), 374–401, 2012.) have produced examples in which the Buchen–Kelly algorithm becomes numerically unstable, and we use these as test cases to show that the algorithm given here remains stable and leads to good results.     

Remarks on a Strongly Nonlinear Model for Two‐Layer Flows with a Top Free Surface

We revisit in this paper the strongly nonlinear long wave model for large amplitude internal waves in two‐layer flows with a free surface proposed by Choi and Camassa [1] and Barros et al. [2]. Its solitary‐wave solutions were the object of the work by Barros and Gavrilyuk [3], who proved that such solutions are governed by a Hamiltonian system with two degrees of freedom. A detailed analysis of the critical points of the system is presented here, leading to some new results. It is shown that conjugate states for the long wave model are the same as those predicted by the fully nonlinear Euler equations. Some emphasis will be given to the baroclinic mode, where interfacial waves are known to change polarity according to different values of density and depth ratios. A critical depth ratio separates these two regimes and its analytical expression is derived directly from the model. In addition, we prove that such waves cannot exist throughout the whole range of speeds.     

A note on the regularity of the free boundaries in the optimal partial transport problem

In this work we study the global regularity of the free boundaries arising in the optimal partial transport problem. Assuming the supports of both the source and the target measure to be convex, we show that the free boundaries of the active regions are globally C ^0,1/2.      

A boundary element method to price time-dependent double barrier options

In this paper we propose a new method for pricing double-barrier options with moving barriers under the Black-Scholes and the CEV models. First of all, by applying a variational technique typical of the boundary element method, we derive an integral representation of the double-barrier option price in which two of the integrand functions are not given explicitly but must be obtained solving a system of Volterra integral equations of the first kind. Second, we develop an ad hoc numerical method to regularize and solve the system of integral equations obtained. Several numerical experiments are carried out showing that the overall algorithm is extraordinarily fast and accurate, even if the barriers are not differentiable functions. Moreover the numerical method presented in this paper performs significantly better than the finite difference approach.