Convergence of Inverse Volatility Problem Based on Degenerate Parabolic Equation

Yilihamujiang Yimamu and Zuicha Deng
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Yilihamujiang Yimamu: Department of Mathematics, Lanzhou Jiaotong University, Lanzhou 730070, China
Zuicha Deng: Department of Mathematics, Lanzhou Jiaotong University, Lanzhou 730070, China

Mathematics, 2022, vol. 10, issue 15, 1-22

Abstract: Based on the theoretical framework of the Black–Scholes model, the convergence of the inverse volatility problem based on the degenerate parabolic equation is studied. Being different from other inverse volatility problems in classical parabolic equations, we introduce some variable substitutions to convert the original problem into an inverse principal coefficient problem in a degenerate parabolic equation on a bounded area, from which an unknown volatility can be recovered and deficiencies caused by artificial truncation can be solved. Based on the optimal control framework, the problem is transformed into an optimization problem and the existence of the minimizer is established, and a rigorous mathematical proof is given for the convergence of the optimal solution. In the end, the gradient-type iteration method is applied to obtain the numerical solution of the inverse problem, and some numerical experiments are performed.

Keywords: inverse volatility problem; degenerate parabolic equation; optimal control framework; existence; convergence; numerical experiments (search for similar items in EconPapers)
JEL-codes: C (search for similar items in EconPapers)
Date: 2022
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