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Efficient numerical methods for pricing American options under stochastic volatility. (English) Zbl 1152.91516

Summary: Five numerical methods for pricing American put options under Heston’s stochastic volatility model are described and compared. The option prices are obtained as the solution of a two-dimensional parabolic partial differential inequality. A finite difference discretization on nonuniform grids leading to linear complementarity problems with M-matrices is proposed. The projected SOR, a projected multigrid method, an operator splitting method, a penalty method, and a componentwise splitting method are considered. The last one is a direct method while all other methods are iterative. The resulting systems of linear equations in the operator splitting method and in the penalty method are solved using a multigrid method. The projected multigrid method and the componentwise splitting method lead to a sequence of linear complementarity problems with one-dimensional differential operators that are solved using the Brennan and Schwartz algorithm. The numerical experiments compare the accuracy and speed of the considered methods. The accuracies of all methods appear to be similar. Thus, the additional approximations made in the operator splitting method, in the penalty method, and in the componentwise splitting method do not increase the error essentially. The componentwise splitting method is the fastest one. All multigrid-based methods have similar rapid grid independent convergence rates. They are about two or three times slower that the componentwise splitting method. On the coarsest grid, the speed of the projected SOR is comparable with the multigrid methods while on finer grids it is several times slower.

MSC:

91G60 Numerical methods (including Monte Carlo methods)
65M99 Numerical methods for partial differential equations, initial value and time-dependent initial-boundary value problems
65M06 Finite difference methods for initial value and initial-boundary value problems involving PDEs
91G20 Derivative securities (option pricing, hedging, etc.)
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