Efficient pricing of options in jump–diffusion models: Novel implicit–explicit methods for numerical valuation

Vikas Maurya, Ankit Singh, Vivek S. Yadav and Manoj K. Rajpoot

Mathematics and Computers in Simulation (MATCOM), 2024, vol. 217, issue C, 202-225

Abstract: This paper presents novel implicit–explicit Runge–Kutta type methods for numerically simulating partial integro-differential equations that arise when pricing options under jump–diffusion models. These methods offer an alternative approach that avoids the need for numerical or analytical inversion of the coefficient matrix. The pricing of European options is formulated as a partial integro-differential equation, while the pricing of American options are treated as a linear complementarity problem. The developed implicit–explicit Runge–Kutta type method is combined with an operator splitting technique to efficiently solve the linear complementarity problem. Stability and convergence analysis of the proposed methods are established using discrete ℓ2-norm. To validate their efficiency and accuracy, the methods are applied to pricing European and American options under Merton’s and Kou’s models, and the computed results are compared with those reported in the literature.

Keywords: Partial integro-differential equation; Merton’s and Kou’s models; European and American option pricing; Implicit–explicit numerical methods; Linear complementarity problem; Stability analysis (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:matcom:v:217:y:2024:i:c:p:202-225

DOI: 10.1016/j.matcom.2023.10.025

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