Automatic differentiation for diffusion operator integral variance reduction

Johan Auster

Journal of Computational Finance

Abstract: This paper demonstrates applications of automatic differentiation with nested dual numbers in the diffusion operator integral variance-reduction framework originally proposed by Heath and Platen. Combining this estimator with automatic differentiation techniques for computing value function sensitivities allows for a flexible implementation without trade-offs in numerical stability or accuracy. This fully mitigates a key practical shortcoming of the original estimator, as we remove the dependency on error-prone and problem-specific manual calculations. We perform a relative error analysis of the estimator and standard Monte Carlo estimation against the numerical integration solution of the European call option in the Heston model and find computational time savings in excess of three orders of magnitude for the same expected relative errors for an at-the-money option. The implementation is further extended to the valuation of discrete down-and-out barrier call options and floating-strike lookback put options, demonstrating the relative ease of applying the automatic differentiation approach to path-dependent options with monitoring bias corrections.

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