The Bismut-Elworthy-Li formula for jump-diffusions and applications to Monte Carlo pricing in finance
AbstractWe extend the Bismut-Elworthy-Li formula to non-degenerate jump diffusions and "payoff" functions depending on the process at multiple future times. In the spirit of Fournie et al  and Davis and Johansson  this can improve Monte Carlo numerics for stochastic volatility models with jumps. To this end one needs so-called Malliavin weights and we give explicit formulae valid in presence of jumps: (a) In a non-degenerate situation, the extended BEL formula represents possible Malliavin weights as Ito integrals with explicit integrands; (b) in a hypoelliptic setting we review work of Arnaudon and Thalmaier  and also find explicit weights, now involving the Malliavin covariance matrix, but still straight-forward to implement. (This is in contrast to recent work by Forster, Lutkebohmert and Teichmann where weights are constructed as anticipating Skorohod integrals.) We give some financial examples covered by (b) but note that most practical cases of poor Monte Carlo performance, Digital Cliquet contracts for instance, can be dealt with by the extended BEL formula and hence without any reliance on Malliavin calculus at all. We then discuss some of the approximations, often ignored in the literature, needed to justify the use of the Malliavin weights in the context of standard jump diffusion models. Finally, as all this is meant to improve numerics, we give some numerical results with focus on Cliquets under the Heston model with jumps.
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Bibliographic InfoPaper provided by arXiv.org in its series Papers with number math/0604311.
Date of creation: Apr 2006
Date of revision: May 2007
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- Eric Benhamou, 2002. "Smart Monte Carlo: various tricks using Malliavin calculus," Quantitative Finance, Taylor & Francis Journals, Taylor & Francis Journals, vol. 2(5), pages 329-336.
- Eric Benhamou, 2002. "Smart Monte Carlo: Various tricks using Malliavin calculus," Finance, EconWPA 0212004, EconWPA.
- Mark Broadie & Paul Glasserman, 1996. "Estimating Security Price Derivatives Using Simulation," Management Science, INFORMS, INFORMS, vol. 42(2), pages 269-285, February.
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