 A general continuous time Markov chain approximation for multi-asset option pricing with systems of correlated diffusionsJ. Lars Kirkby, Dang H. Nguyen and Duy Nguyen Applied Mathematics and Computation, 2020, vol. 386, issue C Abstract: Continuous time Markov Chain (CTMC) approximation techniques have received increasing attention in the option pricing literature, due to their ability to solve complex pricing problems, although existing approaches are mostly limited to one or two dimensions. This paper develops a general methodology for modeling and pricing financial derivatives which depend on systems of stochastic diffusion processes. This is accomplished with a general decorrelation procedure, which reduces the system of correlated diffusions to an uncorrelated system. This enables simple and efficient approximation of the driving processes by univariate CTMC approximations. Weak convergence of the approximation is demonstrated, with second order convergence in space. Numerical experiments demonstrate the accuracy and efficiency of the method for various European and early-exercise options in two and three dimensions. Keywords: Options pricing; CTMC; Markov chain; Diffusion; Spread options; Rainbow options; Basket options; Multi asset; Exotic option; PDE (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:apmaco:v:386:y:2020:i:c:s0096300320304318 DOI: 10.1016/j.amc.2020.125472 Access Statistics for this article Applied Mathematics and Computation is currently edited by Theodore Simos More articles in Applied Mathematics and Computation from Elsevier |
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