Questions tagged [parabolic-pde]
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26
questions
3
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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 ...
1
vote
0
answers
166
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Market models of implied volatility and no arbitrage
Something has been bugging me for a while, and I can't really find an answer to it in papers. Maybe somebody can help me out.
In addition to modelling the instantaneous vol, or modelling forward ...
2
votes
0
answers
119
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Numerical scheme for this HJB equation
Without dwelling on details on how to obtain the HJB equation for this problem, I would like to know if the scheme I wrote for solving it numerically is viable or did I miss something.
I need to solve ...
2
votes
1
answer
140
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Feynman-Kac representation of Black-Cox model
Consider the standard setup from Black and Cox (1976, Journal of Finance).
A firm issues a defaultable coupon bond to finance a productive asset that follows a geometric brownian motion:
$$dx_t = \mu ...
3
votes
0
answers
120
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Explicit form for forwards Feynman-Kac formula
This might be a simple question, but I'm having trouble with it.
Consider the Cauchy problem with final condition.
\begin{equation}
\begin{cases}
\frac{\partial u}{\partial t}(t,x) + \mathcal{L}u(t,x) ...
8
votes
1
answer
950
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Hyperbolic and Elliptic PDEs in Quant Finance
Parabolic PDEs (e.g. heat equation) are closely linked to finance via the Feynman Kac Theorem.
Do other types of PDEs appear in quant finance? Elliptic PDEs don't contain a time dimension (so perhaps ...
1
vote
1
answer
677
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Linear Or nonlinear Black Scholes Equation
I have been going through the analytical solutions of black scholes equation which transforms it to a heat equation.
$$u_{t}=\frac{1}{2}\sigma^{2}u_{xx}$$
Now if the volatility is constant , then its ...
2
votes
1
answer
102
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Numerical Solution to 3 Dimensional Backward BS PDE
I have a three dimensional backward BS PDE.
$$ \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{\...
2
votes
0
answers
715
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Black-Scholes equation to Heat equation .(Boundary conditions)
I have been given a problem to code the heat equation which is transformed from B-S equation (European call option) .
Now the boundary conditions are for European call option:
$$C(S,T)=\max(S-K,0)$$...
2
votes
0
answers
564
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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 ...
4
votes
1
answer
343
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Bond PDE under an Affine Jump Diffusion model
Under the Jump extended Vasicek model, the dynamics of the short rate are as follow :
$$dr_t=\kappa(\theta-r_t)dt+\sigma\sqrt{r_t}\,dW_t+d\left(\sum\limits_{i=1}^{N_t}\,J_i\right)$$
where $N_t$ ...
2
votes
1
answer
181
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Unable to obtain correct Finite Difference Results
A rather general question regarding a specific problem I am facing with my Matlab implementation of the implicit FD method for this PDE:
\begin{equation}
\frac{\sigma_s^2}{2}\frac{\partial^2 V}{\...
2
votes
1
answer
266
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What is the domain of the Black-Scholes operator?
By the Black-Scholes operator I mean the following.
$$L_{BS}u(x) = \frac{1}{2}\sigma^2x^2\frac{\partial^2}{\partial x^2}u(x) + rx\frac{\partial}{\partial x}u(x) - ru(x)$$
Obviously, the domain of $...
1
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0
answers
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Prove that $F(s,x_0)=0$, $F(t,x)=1$ and $\frac{\partial F}{\partial t}+\frac{1}{2}\frac{\partial^2 F}{\partial x^2}=0$
Using the Dynkin's formula, prove that $F(s,x_0)=0$, $F(t,x)=1$ and $\frac{\partial F}{\partial t}+\frac{1}{2}\frac{\partial^2 F}{\partial x^2}=0$
where $F(s,t)=2\int_{x-x_0}^{\infty}\frac{1}{\sqrt{2\...
0
votes
1
answer
86
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Which PDE is satisfied by the function of Wiener process $u(t,x)$?
Suppose you have the following function:
$u(t,x)=\mathbb{E}[f(xe^{W_t+\frac{1}{2}t})]$, where $W_t$ is a Wiener process.
Let us first differentiate:
$du=\mathbb{E}[f'(xe^{W_t+\frac{1}{2}t})(e^{W_t-\...
4
votes
0
answers
2k
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Black-Scholes PDE - Change of Variables
In the derivation below, I cannot figure out how to solve for "Step 3". Can anyone help me walk through the steps in detail?
Derivation:
10
votes
1
answer
1k
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Advantage of solving the Fokker-Planck equation over Monte-Carlo simulations
For a standard Ito process
$$dX_t = \mu(X_t, t) \,dt + \sigma(X_t, t) \,dW_t,$$
the Fokker-Planck or forward Kolmogorov equation gives an equation for the probability density $p ( x , t )$ of the ...
3
votes
0
answers
677
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Ill-posed problem: Local volatility calibration. Regularization vs Smoothing
I have asked my question on Mathematics site of Stack Exchange but maybe I will get the answer rather here.
I am working on inverse problem - calibration of local volatility (financial application). ...
1
vote
1
answer
220
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Gatheral's change of variables for stochastic volatility PDE
This is taken from Gatheral's book "The Volatility Surface", where he tries to go from equation 2.3 to equation 2.4.
We have the following PDE,
$$
\frac{\partial V}{\partial t}+\frac{1}{2}vS^2\frac{...
0
votes
1
answer
90
views
pricing a derivative with a running cost
Assume I pricing some commodity derivative that has a running cost with $\$c$ being paid per unit of time. So I define the price under the risk neutral measure to be $$P(t,S_t)=\tilde{\mathbb{E}}\left[...
2
votes
2
answers
4k
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Feynman Kac and choice of measure
I seem to be confused on this topic. So I write my SDE without a drift to make it simple: $$dX_t=dW_t$$ and before I get to any finance there is a relation
that the solution to $$u_t+0.5u_{xx}-ru=0$$ ...
0
votes
1
answer
79
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parabolic pde with source term
I was wondering if someone is aware of the application when pdes of the form arise
$$u_t+u_{xx}+g=0$$
i.e. there is a source term now. Any financial instruments that have this type of pde?
5
votes
1
answer
473
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Other numerraire choices when applying Feynman Kac
all of the books and notes I have seen on the Feynman Kac formula mostly applied to Risk neutral measure, i.e. different interest rate models, stochastic volatility, etc. I think risk neutral measure ...
2
votes
1
answer
162
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Black Derman Toy short rate and PDE
I am looking at the Black Derman Toy local short rate model as
$$d\log r(t)=\alpha(t)(\theta (t)-\log r(t))dt+\sigma dW(t)$$
under RN measure. I would like to derive the bond price PDE. For that I ...
4
votes
1
answer
741
views
Solving a backwards heat equation using stochastic calculus
Given the PDE
$$\frac{\partial F}{\partial t} + \frac{1}{2}\sigma^2 \frac{\partial^2 F}{\partial x^2} = 0$$
with condition $F(T,x) = x^2$, one can use the Feynman-Kac formula to arrive at
$$F(t,x) =...
4
votes
0
answers
104
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European call option delta and maximum principle
From comments, the maximum principle for parabolic PDE can be used to show that the European call option delta cannot be greater than 1. I am looking forward to such derivations.