ON ERRORS AND BIAS OF FOURIER TRANSFORM METHODS IN QUADRATIC TERM STRUCTURE MODELS

Nina Boyarchenko and Sergei Levendorskiǐ ()
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Sergei Levendorskiǐ: Department of Economics, The University of Texas at Austin, 1 University Station C3100, Austin, TX 78712-0301, USA

International Journal of Theoretical and Applied Finance (IJTAF), 2007, vol. 10, issue 02, 273-306

Abstract: We analyze and compare the performance of the Fourier transform method in affine and quadratic term structure models. We explain why the method of the reduction to FFT in dimension 1 is efficient for ATSMs of type A0(n), but may lead to sizable errors for QTSMs unless computational errors are taken into account properly. We suggest a certain improvement and generalization which make FFT more accurate and, for the same precision, faster than the Leippold and Wu [M. Leippold and L. Wu, Option pricing under the quadratic class, Journal of Financial and Quantitative Analysis 37(2) (2002) 271–295] method. We deduce simple general recommendations for the choice of parameters of computational schemes for QTSMs, which ensure a given precision, and an approximate formula for the bias which FFT produces.

Keywords: Derivative pricing; quadratic term structure models; Fourier transform; fast Fourier transform (search for similar items in EconPapers)
Date: 2007
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Citations: View citations in EconPapers (3)

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DOI: 10.1142/S0219024907004238

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