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Applying Finite Difference Method to Heat Equation (transformed from Black-Scholes equation) [closed]

We will make the following definitions: $S$ - Asset price $t$ - Time $T$ - Time of maturity $V$ - Option price $\sigma$ - Volatility $S_0$ - Initial price $K$ - Strike price I have the following heat ...
Naji's user avatar
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Inverse differencing in continuous time

I want to fit a continuous time ARMA (CARMA) model to traffic data $T_t$. After removing trend and seasonality I need first order differencing to obtain stationarity. Then I fit a CARMA model (yuima ...
Valentin's user avatar
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2 votes
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65 views

How are opitons greeks computed for models that require numerical PDE solving [closed]

I am often told that options priced under SLV models, the Greeks cannot be exactly replicated by finite differences, but are computed at the level of the grid used to solve the PDE. Can someone please ...
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Finite difference methods for an Asian call with boundary conditions

I have a question please. I have to find the price of a Asian call using a finite diffenrece method. Here the article, if u want to look it up, it's page 2-4: "https://www.researchgate.net/...
Raphael Morel's user avatar
3 votes
0 answers
68 views

Finite difference method for the Heston model using the ADI scheme

I am trying to implement the ADI FDM scheme for the heston and I am following The Heston Model and Its Extensions in Matlab and C#. They have the scheme: $$U'(t) = \textbf{L}U(t),$$ $$\textbf{L} = A_0 ...
Xerium's user avatar
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2 votes
0 answers
81 views

Feller Condition in the Heston Model

I understand that for MC simulations we require the Feller Condition otherwise the simulation becomes unstable when approximating the events when $v_t<0$, but for semi-analytical solution and using ...
Xerium's user avatar
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What are the boundary conditions for an up-and-out binary call option of Bermudan type?

I know that an up-and-out binary call option of American type will never knock out if barrier is greater than the strike since the option stops immediately if the stock price touches the strike due to ...
Meraki's user avatar
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Books on Finite Differences by Duffy

There is a well-known book from 2006 by Daniel Duffy, which is Finite Difference Methods in Financial Engineering: A Partial Differential Equation Approach. You may find it here on Wiley's: https://...
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477 views

Explicit Finite Difference method to price European Call in Python

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hener's user avatar
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1 answer
291 views

Black Scholes PDE explicit Scheme

I am currently working on the implementation of classic schemes to solve the BS PDE and it seems that I make a mistake in my code because the result looks far from the result of the BS formula. Here ...
Petra Di Mario's user avatar
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108 views

For derivatives pricing, does FEM actually ever outperform FDM?

Simple question that I was wondering about over during the weekend. I have done a little FEM during the last years and my university time and did not spend a lot of time with FDM. For a new job I have ...
freistil90's user avatar
4 votes
1 answer
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Convergence rate of Bermudan to American option

When trying to value an American option we often use grid-based methods (e.g. Monte Carlo in combination with Longstaff Schwartz; or Finite Difference Methods). As such, we are in fact estimating the ...
Landscape's user avatar
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Finite Difference Application

We all know that the traditional BS equation is: $$\frac{\partial \mathrm V}{ \partial \mathrm t } + \frac{1}{2}\sigma^{2} \mathrm S^{2} \frac{\partial^{2} \mathrm V}{\partial \mathrm S^2} + \...
Eduardo Contreras's user avatar
2 votes
1 answer
242 views

How to solve numerically the IDE of GUILBAUD & PHAM model?

By the Guilbaud & Pham model (Optimal high frequency trading with limit and market orders, 2011), the authors said that integro-differential-equation (IDE) can be easily solved by numerical method....
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1 answer
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Boundary condition issues for Black-Scholes PDE using finite-differences

I have been implementing an, in my opinion, interesting finite difference method (Runge-Kutta-Legendre of second order) to price American options in the standard Black-Scholes model (see "...
Jesper Tidblom's user avatar
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1 answer
208 views

Numerically stable method for estimating $\partial_t \mathbb{E}[f(X_t)]$ where $X_t$ is an n-dim Ito process and $f:\mathbb{R}^n\rightarrow\mathbb{R}$

Assume $(X_t)_{t\geq 0}$ follows an SDE of the form: $$dX_t = a(t, X_t) dt + b(t, X_t) dW_t$$ where $W$ is a standard $n$-dimensional Brownian motion, $a$ and $b$ are mappings from $\mathbb{R}_+\times\...
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Finite difference methods with discontinuity in the payoff function

I have implemented a finite difference scheme for pricing options using a Black-Scholes-like model. I tested my implementation on a call option, and found that it gave extremely inaccurate results. I ...
user59155's user avatar
2 votes
0 answers
60 views

Approximating second derivatives at boundary of finite difference scheme

The Question I am implementing a finite difference scheme for the Heston-Hull-White PDE: \begin{align} \frac{\partial u}{\partial t} &= \frac{1}{2}s^2v\frac{\partial^2 u}{\partial s^2 } + \frac{1}{...
user59093's user avatar
1 vote
0 answers
71 views

Dealing with the ru term in an ADI Finite Difference Scheme

I'm trying to code up the algorithm from this paper. The paper presents an ADI algorithm for pricing options in the Heston-Hull-White model. The starting point is the Heston-Hull-White PDE, given ...
user54908's user avatar
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1 answer
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Finite Difference Method in Greeks (Options)

I need a way to approximate the analytical formula of Greeks of a generic call option using the Finite Difference Method. For example, the FD method for Delta/Gamma is the following one: Now, I am in ...
John_maddon's user avatar
1 vote
1 answer
232 views

Question on boundary conditions when using Finite Difference

I have two questions appearing to me (they are not related directly to each other). My first question is about boundary conditions when using Finite difference methods. There are two ways to do it: a)...
alphaH's user avatar
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0 answers
24 views

Calculate error at all spatial indices for a given time step between BS equation and its numerical solution using explicit method

I am using the explicit finite backward difference scheme to discretize and calculate the price of an European call option in a discretization stencil. My goal is to find the error at a given time ...
atastix's user avatar
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7 votes
1 answer
559 views

Negative Density in Local Stochastic Volatility (LSV) Model Calibration

I'm trying to calibrate Local stochastic volatility model using finite difference method, and I'm mainly following this referece: Tian (2015). I met a problem when calibrating leverage function - the ...
Dovie Chu's user avatar
  • 121
2 votes
2 answers
2k views

Boundary Conditions for Call Option in Black Scholes Model

Let $C(t,S)$ be the value function of a call option. I want to price that option using (explicit) finite differences and the Black Scholes PDE. I consider the grid $0=t_0<t_1<...<t_{N-1}<...
Alex's user avatar
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1 vote
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177 views

Implicit Scheme for Cox-Ingersoll-Ross Model PDE

I am considering the PDE for the price of a bond $V(r,t)$ with maturity $T$ under the Cox-Ingersoll-Ross model, $$V_t+\frac12\sigma^2rV_{rr}+\nu(\theta-r)V_r-rV=0\quad r>0, t\in(0,1)$$ with ...
user107224's user avatar
4 votes
1 answer
133 views

Maximum norm stability for implicit Black-Scholes equation

I am trying to prove maximum norm stability for the following implicit approximation to the Black-Scholes equation $$\frac1{\Delta t}\left(U_j^{(n+1)}-U_j^{(n)}\right)+\frac{rS_j}{\Delta S}\left(U_{j+...
user107224's user avatar
1 vote
0 answers
47 views

Quick Discretization question for finite difference and finite element methods

Assume we have the discretization in space $x_1, x_2, ... , x_M$ and time $t_1, t_2, ... , t_N$ for a finite difference or finite element method for option pricing and we want to solve for the option ...
sigma1988's user avatar
1 vote
0 answers
81 views

boundary conditions in finite element method

In the appendix A of this paper, https://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.227.5073&rep=rep1&type=pdf, a finite element method is demonstrated to price a straddle. The same ...
sigma1988's user avatar
1 vote
1 answer
693 views

Negative theta for a short put

I am getting a negative theta for a short put deal Is it possible and if yes then under what conditions. Kindly explain I am just learning these concepts so my question may sound vague to some of you ...
Novice's user avatar
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0 answers
177 views

Issue in Understanding the Boundary Conditions for European Call Option in Implicit Finite Difference Method

I have a working Python code which prices European call option in Implicit Finite Difference setting. However, I am unable to understand the Boundary Conditions implemented on the coefficient matrix ...
Desi_Quant's user avatar
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0 answers
185 views

Error in Call Option Valuation using Implicit Finite Difference implemented in Python

I am trying to valuate call option using implicit Finite difference method (Forward Marching) implemented in Python. However I am getting the error in the code. Following is the code I have developed: ...
Desi_Quant's user avatar
3 votes
1 answer
837 views

Greeks: Estimate gamma by Monte Carlo finite difference

When I was using Monte Carlo to calculate the gamma of a vanilla call option by finite difference method, I stuck in this weird situation as below. Consider this, $$ Gamma = \frac{CallPrice(S^{up}_{T})...
PeterSung's user avatar
3 votes
0 answers
108 views

Operator splitting method on three assets black scholes equation

Currently I am studying finite difference method on derivatives with three (or more) underlyings and little bit confused on operator splitting method because two papers have different result. For the ...
whatamisaying's user avatar
2 votes
2 answers
336 views

Implicit finite difference method always guarantees positive and stable price of derivative?

For the following black scholes pde $$ f_t + rSf_S+\frac{1}{2}\sigma^2S^2f_{SS} = rf $$ By denoting $f_{i}^{n} = $ Price of derivative at price node $i$ and time node $n$ and assume uniform grid, the ...
spar7453's user avatar
8 votes
2 answers
645 views

Improve Finite Difference Scheme

I understand how to derive and implement standard finite difference schemes. I wonder how to improve such a standard FD scheme? For example, when solving the standard Black-Scholes equation, the ...
Alex's user avatar
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2 votes
0 answers
241 views

Stability of Finite Difference method for Breeden-Litzenberger

I am trying to derive a risk-neutral density from European call option prices using a second order finite difference scheme. Let $C(K,T)$ be the price of a European call with strike $K$ and expiry $T$ ...
user39039's user avatar
  • 451
1 vote
1 answer
141 views

Canonical text on numerical PDEs in finance

I am looking for a text similar to Glasserman's Monte Carlo Methods in Financial Engineering, but with a focus on numerical methods for PDEs. Glasserman's book seems to cover a lot for what is ...
fwd_T's user avatar
  • 747
7 votes
1 answer
270 views

Benchmark a Libor Market Model implementation

Assume I have implemented a solution of the Libor Market model PDE in terms of the Finite Difference method. What is a good strategy for validating and benchmarking the results of this implementation? ...
davidhigh's user avatar
  • 348
2 votes
1 answer
102 views

Numerical Solution to 3 Dimensional Backward BS PDE

I have a three dimensional backward BS PDE. $$ \frac{\partial V}{\partial t} + a(t) S \frac{\partial V}{\partial S} + \frac{1}{2} \sigma(t, S)^2 \frac{\partial^2 V}{\partial S^2} + b(t, M) \frac{\...
holox's user avatar
  • 29
2 votes
2 answers
6k views

Local Volatility calculation in Python

I am trying to price Local Volatility in Python using Dupire (Finite Difference Method). I have following set of information Spot: 770.05, Strike: 850, Type: 'C', rfr: 0.0066, time to maturity = ...
Add's user avatar
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1 vote
0 answers
757 views

Pricing Knock Out Barrier Options by solving Black Scholes PDE (MATLAB)

This question is based on MATLAB functions. Suppose there is a stock S following the process $dS_t=(r-q)S_tdt+\sigma(S_t,t)dW_t$ r - risk-free rate, q - dividend yield, W - Weiner process The ...
Ranaji 's user avatar
2 votes
1 answer
149 views

Finite difference methods for (continuously) strike-resettable American options

For simplicity, let us consider an American call/put with a continuously resettable strike price. Current time is $t=0$, maturity is at $t=T$, and the initial strike is $K_0$. We consider a "...
Vim's user avatar
  • 903
4 votes
2 answers
655 views

Is it possible to model path-dependent clauses using finite difference methods?

I'm trying to build a convertible bond pricer. In my case a convertible bond is a complex derivative with call, put and conversion price reset clauses, and all of the clauses are triggered in a path-...
Vim's user avatar
  • 903
1 vote
1 answer
308 views

Explicit Euler stability for the Heat Equation (FDM)

Why the Explicit Euler scheme for the Heat Equation is stable only if $k \leq h^2/2$ ? Here is the difference equation: \begin{equation} \frac{U_j^{n+1}-U_{j}^n}{k} = \frac{1}{h^2}(U_{j+1}^n-2U_j^n+...
Victor's user avatar
  • 519
3 votes
2 answers
863 views

Binomial Trees vs FDM

Binomial trees as the number of time steps is increased (or equivalently as the time step tends to 0), converge to the exact value for an option. So why do people use FDM for pricing options (for ...
Victor's user avatar
  • 519
2 votes
0 answers
158 views

American-Bermudan-Asian option fixed strike using finite differences

I'm trying to price the same American-Bermudan-Asian option described in Longstaff Schwartz (2001). Specifically, using finite difference methods with an explicit scheme to solve $\begin{aligned} \...
foreignvol's user avatar
3 votes
1 answer
483 views

Errors on Finite Differences + Implicit Scheme + Black & Scholes

I'm solving the classical Black & Scholes (BS) PDE for a European option using finite difference and the implicit scheme. In other words, I'm trying to solve $\displaystyle\frac{\partial V}{\...
foreignvol's user avatar
2 votes
0 answers
606 views

How do you numerically solve the Dupire Local Volatility PDE in log moneyness-time space?

I am trying to implement a numerical solution to price vanilla calls. I am using the Dupire equation in log moneyness-time (k = ln(F/T)) space as per below PDE I have tried solving it using a fully ...
MikeMan's user avatar
  • 21
1 vote
0 answers
137 views

Optimal allocation problem by finite differences

I am attempting to apply implicit finite difference to solve Merton's problem of optimal portfolio allocation for constant parameters. The equation to solve is the Hamilton-Jacobi-Bellman equation: $$...
scrps93's user avatar
  • 113
1 vote
1 answer
58 views

How many decimals of accuracy can I expect from FDM and MC (both valuation and risk)

I have implemented some Monte Carlo and FDM code. I can then get greeks by bumping. I am comparing to to exact formulas of price + greeks, and am wondering how many decimals of accuracy I can expect ...
Marquee's user avatar
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