Enhancing finite difference approximations for double barrier options: mesh optimization and repeated Richardson extrapolation

Luca Vincenzo Ballestra

Computational Management Science, 2021, vol. 18, issue 2, No 6, 239-263

Abstract: Abstract We show that the performances of the finite difference method for double barrier option pricing can be strongly enhanced by applying both a repeated Richardson extrapolation technique and a mesh optimization procedure. In particular, first we construct a space mesh that is uniform and aligned with the discontinuity points of the solution being sought. This is accomplished by means of a suitable transformation of coordinates, which involves some parameters that are implicitly defined and whose existence and uniqueness is theoretically established. Then, a finite difference scheme employing repeated Richardson extrapolation in both space and time is developed. The overall approach exhibits high efficacy: barrier option prices can be computed with accuracy close to the machine precision in less than one second. The numerical simulations also reveal that the improvement over existing methods is due to the combination of the mesh optimization and the repeated Richardson extrapolation.

Keywords: Double barrier option; Mesh optimization; Richardson extrapolation; High-order accuracy; Finite difference method (search for similar items in EconPapers)
Date: 2021
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DOI: 10.1007/s10287-021-00394-9

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