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Analytical Approximation for Non-linear FBSDEs with Perturbation Scheme

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  • Masaaki Fujii, Akihiko Takahashi

    (Faculty of Economics, University of Tokyo)

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    Abstract

    In this work, we have presented a simple analytical approximation scheme for generic non-linear FBSDEs. By treating the interested system as the linear decoupled FBSDE perturbed with non-linear generator and feedback terms, we have shown that it is possible to carry out a recursive approximation to an arbitrarily higher order, where the required calculations in each order are equivalent to those for standard European contingent claims. We have also applied the perturbative method to the PDE framework following the so-called Four Step Scheme. The method is found to render the original non-linear PDE into a series of standard parabolic linear PDEs. Due to the equivalence of the two approaches, it is also possible to derive approximate analytic solution for the non-linear PDE by applying the asymptotic expansion to the corresponding probabilistic model. Two simple examples are provided to demon-strate how the perturbation works and show its accuracy relative to known numerical techniques. The method presented in this paper may be useful for various important problems which have eluded analytical treatment so far.

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    File URL: http://www.carf.e.u-tokyo.ac.jp/pdf/workingpaper/fseries/280.pdf
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    Bibliographic Info

    Paper provided by Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo in its series CARF F-Series with number CARF-F-269.

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    Length: 36 pages
    Date of creation: Jan 2012
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    Handle: RePEc:cfi:fseres:cf269

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