Pricing Two-asset Options under Exponential L\'evy Model Using a Finite Element Method

Xun Li, Ping Lin, Xue-Cheng Tai and Jinghui Zhou

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Abstract: This article presents a finite element method (FEM) for a partial integro-differential equation (PIDE) to price two-asset options with underlying price processes modeled by an exponential Levy process. We provide a variational formulation in a weighted Sobolev space, and establish existence and uniqueness of the FEM-based solution. Then we discuss the localization of the infinite domain problem to a finite domain and analyze its error. We tackle the localized problem by an explicit-implicit time-discretization of the PIDE, where the space-discretization is done through a standard continuous finite element method. Error estimates are given for the fully discretized localized problem where two assets are assumed to have uncorrelated jumps. Numerical experiments for the polynomial option and a few other two-asset options shed light on good performance of our proposed method.

Date: 2015-11
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