On Weak Predictor-Corrector Schemes for Jump-Diffusion Processes in Finance

Nicola Bruti-Liberati and Eckhard Platen ()

No 179, Research Paper Series from Quantitative Finance Research Centre, University of Technology, Sydney

Abstract: Event-driven uncertainties such as corporate defaults, operational failures or central bank announcements are important elements in the modelling of financial quantities. Therefore, stochastic differential equations (SDEs) of jump-diffusion type are often used in finance. We consider in this paper weak discrete time approximations of jump-diffusion SDEs which are appropriate for problems such as derivative pricing and the evaluation of risk measures. We present regular and jump-adapted predictor-corrector schemes with first and second order of weak convergence. The regular schemes are constructed on regular time discretizations that do not include jump times, while the jump-adapted schemes are based on time discretizations that include all jump times. A numerical analysis of the accuracy of these schemes when applied to the jump-diffusion Merton model is provided.

Keywords: weak approximations; Monte Carlo simulations; predictor-corrector schemes; jump diffusions (search for similar items in EconPapers)
JEL-codes: G10 G13 C63 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fin and nep-fmk
Date: 2006-07-01
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