On a semi-spectral method for pricing an option on a mean-reverting asset

L. P. Bos, A. F. Ware and B. S. Pavlov

Quantitative Finance, 2002, vol. 2, issue 5, 337-345

Abstract: We consider a risky asset following a mean-reverting stochastic process of the form [image omitted] We show that the (singular) diffusion equation which gives the value of a European option on S can be represented, upon expanding in Laguerre polynomials, by a tridiagonal infinite matrix. We analyse this matrix to show that the diffusion equation does indeed have a solution and truncate the matrix to give a simple, highly efficient method for the numerical calculation of the solution.

Date: 2002
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DOI: 10.1088/1469-7688/2/5/302

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