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A front-fixing ETD numerical method for solving jump–diffusion American option pricing problems

Rafael Company, Vera N. Egorova and Lucas Jódar

Mathematics and Computers in Simulation (MATCOM), 2021, vol. 189, issue C, 69-84

Abstract: American options prices under jump–diffusion models are determined by a free boundary partial integro-differential equation (PIDE) problem. In this paper, we propose a front-fixing exponential time differencing (FF-ETD) method composed of several steps. First, the free boundary is included into equation by applying the front-fixing transformation. Second, the resulting nonlinear PIDE is semi-discretized, that leads to a system of ordinary differential equations (ODEs). Third, a numerical solution of the system is constructed by using exponential time differencing (ETD) method and matrix quadrature rules. Finally, numerical analysis is provided to establish empirical stability conditions on step sizes. Numerical results show the efficiency and competitiveness of the FF-ETD method.

Keywords: American option pricing; Front-fixing method; Exponential time differencing; Finite difference methods; Experimental numerical analysis; Gauss quadrature (search for similar items in EconPapers)
Date: 2021
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DOI: 10.1016/j.matcom.2020.07.015

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