Low-Dimensional Partial Integro-differential Equations for High-Dimensional Asian Options

Peter Hepperger ()
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Peter Hepperger: Technische Universität München, Mathematische Statistik M4

A chapter in Inspired by Finance, 2014, pp 331-348 from Springer

Abstract: Abstract Asian options on a single asset under a jump-diffusion model can be priced by solving a partial integro-differential equation (PIDE). We consider the more challenging case of an option whose payoff depends on a large number (or even a continuum) of assets. Possible applications include options on a stock basket index and electricity contracts with a delivery period. Both of these can be modeled with an exponential, time-inhomogeneous, Hilbert space valued jump-diffusion process. We derive the corresponding high- or even infinite-dimensional PIDE for Asian option prices in this setting and show how to approximate it with a low-dimensional PIDE. To this end, we employ proper orthogonal decomposition (POD) to reduce the dimension. We generalize the convergence results known for European options to the case of Asian options and give an estimate for the approximation error.

Keywords: Hilbert space valued jump-diffusion; Asian option; Partial integro-differential equation; Dimension reduction; Proper orthogonal decomposition; 91B25; 60H35; 35R15; 35R09 (search for similar items in EconPapers)
Date: 2014
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Persistent link: https://EconPapers.repec.org/RePEc:spr:sprchp:978-3-319-02069-3_15

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DOI: 10.1007/978-3-319-02069-3_15

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