Application of simplest random walk algorithms for pricing barrier options
AbstractWe demonstrate effectiveness of the first-order algorithm from [Milstein, Tretyakov. Theory Prob. Appl. 47 (2002), 53-68] in application to barrier option pricing. The algorithm uses the weak Euler approximation far from barriers and a special construction motivated by linear interpolation of the price near barriers. It is easy to implement and is universal: it can be applied to various structures of the contracts including derivatives on multi-asset correlated underlyings and can deal with various type of barriers. In contrast to the Brownian bridge techniques currently commonly used for pricing barrier options, the algorithm tested here does not require knowledge of trigger probabilities nor their estimates. We illustrate this algorithm via pricing a barrier caplet, barrier trigger swap and barrier swaption.
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Bibliographic InfoPaper provided by arXiv.org in its series Papers with number 1211.5726.
Date of creation: Nov 2012
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Web page: http://arxiv.org/
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-12-10 (All new papers)
- NEP-CMP-2012-12-10 (Computational Economics)
- NEP-FMK-2012-12-10 (Financial Markets)
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- Naoto Kunitomo & Masayuki Ikeda, 1992. "Pricing Options With Curved Boundaries," Mathematical Finance, Wiley Blackwell, vol. 2(4), pages 275-298.
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