A Practical Monte Carlo Method for Pricing Equity-Linked Securities with Time-Dependent Volatility and Interest Rate

Sangkwon Kim (), Jisang Lyu (), Wonjin Lee (), Eunchae Park (), Hanbyeol Jang (), Chaeyoung Lee () and Junseok Kim ()
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Sangkwon Kim: Korea University
Jisang Lyu: Korea University
Wonjin Lee: Korea University
Eunchae Park: Korea University
Hanbyeol Jang: Korea University
Chaeyoung Lee: Korea University
Junseok Kim: Korea University

Computational Economics, 2024, vol. 63, issue 5, No 15, 2069-2086

Abstract: Abstract We develop a fast Monte Carlo simulation (MCS) for pricing equity-linked securities (ELS) with time-dependent volatility and interest rate. In this paper, we extend a recently developed fast MCS for pricing ELS. In the previous model, both the volatility and interest rate were constant. However, in the real finance market, volatility and interest rate are time-dependent parameters. In this work, we approximate the time-dependent parameters by piecewise constant functions and apply Brownian bridge technique. We present some numerical results of the proposed method. The computational results demonstrate the fastness of the proposed algorithm with equivalent accuracy with standard MCS. It is important for traders and hedgers considering derivatives to evaluate prices and risks quickly and accurately. Therefore, our algorithm will be very useful to practitioners in the ELS market.

Keywords: Fast Monte Carlo method; Time-dependent volatility; Time-dependent interest rate; Brownian bridge; Black–Scholes equation (search for similar items in EconPapers)
Date: 2024
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DOI: 10.1007/s10614-023-10394-3

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