Exponential time integration for fast finite element solutions of some financial engineering problems

We consider exponential time integration schemes for fast numerical pricing of European, American, barrier and butterfly options when the stock price follows a dynamics described by a jump-diffusion process. The resulting pricing equation which is in the form of a partial integro-differential equation is approximated in space using finite elements. Our methods require the computation of a single matrix exponential and we demonstrate using a wide range of numerical tests that the combination of exponential integrators and finite element discretisations with quadratic basis functions leads to highly accurate algorithms for cases when the jump magnitude is Gaussian. Comparison with other time-stepping methods are also carried out to illustrate the effectiveness of our methods.     

A new fourth-order numerical scheme for option pricing under the CEV model

The empirically observed negative relationship between a stock price and its return volatility can be captured by the constant elasticity of variance option pricing model. For European options, closed form expressions involve the non-central chi-square distribution whose computation can be slow when the elasticity factor is close to one, volatility is low or time to maturity is small. We present a fast numerical scheme based on a high-order compact discretisation which accurately computes the option price. Various numerical examples indicate that for comparable computational times, the option price computed with the scheme has higher accuracy than the Crank–Nicolson numerical solution. The scheme accurately computes the hedging parameters and is stable for strongly negative values of the elasticity factor.     

A fast high-order finite difference algorithm for pricing American options

We describe an improvement of Han and Wu’s algorithm [H. Han, X.Wu, A fast numerical method for the Black–Scholes equation of American options, SIAM J. Numer. Anal. 41 (6) (2003) 2081–2095] for American options. A high-order optimal compact scheme is used to discretise the transformed Black–Scholes PDE under a singularity separating framework. A more accurate free boundary location based on the smooth pasting condition and the use of a non-uniform grid with a modified tridiagonal solver lead to an efficient implementation of the free boundary value problem. Extensive numerical experiments show that the new finite difference algorithm converges rapidly and numerical solutions with good accuracy are obtained. Comparisons with some recently proposed methods for the American options problem are carried out to show the advantage of our numerical method.     

Duality, triality and complementary extremum principles in non-convex parametric variational problems with applications

This paper presents a reasonably complete duality theory anda nonlinear dual transformation method for solving the fullynonlinear, non-convex parametric variational problem inf{W(u- µ) - F(u)}, and associated nonlinear boundary valueproblems, where is a nonlinear operator, W is either convexor concave functional of p = u, and µ is a given parameter.Detailed mathematical proofs are provided for the complementaryextremum principles proposed recently in finite deformationtheory. A method for obtaining truly dual variational principles(without a dual gap and involving the dual variable p* of uonly) in n-dimensional problems is proposed. It is proved thatfor convex W(p), the critical point of the associated LagrangianL_µ(u, p*) is a saddle point if and only if the so-calledcomplementary gap function is positive. In this case, the systemhas only one dual problem. However, if this gap function isnegative, the critical point of the Lagrangian is a so-calledsuper-critical point, which is equivalent to the Auchmuty'sanomalous critical point in geometrically linear systems. Wediscover that, in this case, the system may have more than oneprimal-dual set of problems. The critical point of the Lagrangianeither minimizes or maximizes both primal and dual problems.An interesting triality theorem in non-convex systems is proved,which contains a minimax complementary principle and a pairof minimum and maximum complementary principles. Applicationsin finite deformation theory are illustrated. An open problemleft by Hellinger and Reissner is solved completely and a purecomplementary energy principle is constructed. It is provedthat the dual Euler-Lagrange equation is an algebraic equation,and hence, a general analytic solution for non-convex variational-boundaryvalue problems is obtained. The connection between nonlineardifferential equations and algebraic geometry is revealed.     

Numerical pricing of options using high-order compact finite difference schemes

We consider high-order compact (HOC) schemes for quasilinear parabolic partial differential equations to discretise the Black–Scholes PDE for the numerical pricing of European and American options. We show that for the heat equation with smooth initial conditions, the HOC schemes attain clear fourth-order convergence but fail if non-smooth payoff conditions are used. To restore the fourth-order convergence, we use a grid stretching that concentrates grid nodes at the strike price for European options. For an American option, an efficient procedure is also described to compute the option price, Greeks and the optimal exercise curve. Comparisons with a fourth-order non-compact scheme are also done. However, fourth-order convergence is not experienced with this strategy. To improve the convergence rate for American options, we discuss the use of a front-fixing transformation with the HOC scheme. We also show that the HOC scheme with grid stretching along the asset price dimension gives accurate numerical solutions for European options under stochastic volatility.     

High-order computational methods for option valuation under multifactor models

Many of the different numerical techniques in the partial differential equations framework for solving option pricing problems have employed only standard second-order discretization schemes. A higher-order discretization has the advantage of producing low size matrix systems for computing sufficiently accurate option prices and this paper proposes new computational schemes yielding high-order convergence rates for the solution of multi-factor option problems. These new schemes employ Galerkin finite element discretizations with quadratic basis functions for the approximation of the spatial derivatives in the pricing equations for stochastic volatility and two-asset option problems and time integration of the resulting semi-discrete systems requires the computation of a single matrix exponential. The computations indicate that this combination of high-order finite elements and exponential time integration leads to efficient algorithms for multi-factor problems. Highly accurate European prices are obtained with relatively coarse meshes and high-order convergence rates are also observed for options with the American early exercise feature. Various numerical examples are provided for illustrating the accuracy of the option prices for Heston’s and Bates stochastic volatility models and for two-asset problems under Merton’s jump-diffusion model.     

Benchmark calculations of some molecular properties of O2, CN and other selected small radicals using the ROHF-CCSD(T) method

The capability of the ROHF-CCSD(T) method in obtaining accurate molecular properties in a defined and controlled way is analysed. Electron affinity, polarizability, and hyperpolarizability of the oxygen molecule in its ground state, electron affinity, electric dipole moment of the CN radical, and some other molecules serve as model cases for obtaining the ‘right result for the right reason’. Most calculated CCSD(T) data were extrapolated to the complete basis set (CBS) limit in order to minimize the basis set dependence of results. Some problems, specific to open shell systems include effects due to the spin adaptation, and details in the selection of the reference orbitals and related selection of denominators in non-iterative triples and other subtleties, which can affect the accuracy of the final ROHF-CCSD(T) results, are investigated.