ADI finite difference schemes for the Heston-Hull-White PDE
AbstractIn this paper we investigate the effectiveness of Alternating Direction Implicit (ADI) time discretization schemes in the numerical solution of the three-dimensional Heston-Hull-White partial differential equation, which is semidiscretized by applying finite difference schemes on nonuniform spatial grids. We consider the Heston-Hull-White model with arbitrary correlation factors, with time-dependent mean-reversion levels, with short and long maturities, for cases where the Feller condition is satisfied and for cases where it is not. In addition, both European-style call options and up-and-out call options are considered. It is shown through extensive tests that ADI schemes, with a proper choice of their parameters, perform very well in all situations - in terms of stability, accuracy and efficiency.
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Bibliographic InfoPaper provided by arXiv.org in its series Papers with number 1111.4087.
Date of creation: Nov 2011
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Publication status: Published in The Journal of Computational Finance 16, 83-110 (2012)
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Web page: http://arxiv.org/
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-11-28 (All new papers)
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- Lech A. Grzelak & Cornelis W. Oosterlee & Sacha Van Weeren, 2012. "Extension of stochastic volatility equity models with the Hull--White interest rate process," Quantitative Finance, Taylor & Francis Journals, Taylor & Francis Journals, vol. 12(1), pages 89-105, July.
- Hull, John & White, Alan, 1990. "Pricing Interest-Rate-Derivative Securities," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 3(4), pages 573-92.
- Grzelak, Lech & Oosterlee, Kees, 2009. "On The Heston Model with Stochastic Interest Rates," MPRA Paper 20620, University Library of Munich, Germany, revised 18 Jan 2010.
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