A Remark on Approximation of the Solutions to Partial Differential Equations in Finance
AbstractThis paper proposes a general approximation method for the solution to a second-order parabolic partial differential equation(PDE) widely used in finance through an extension of Léeandre's approach(Léandre (2006,2008)) and the Bismut identiy(e.g. chapter IX-7 of Malliavin (1997))] in Malliavin calculus. We present two types of its applications, approximations of derivatives prices and short-time asymptotic expansions of the heat kernel. In particular, we provide approximate formulas for option prices under local and stochastic volatility models. We also derive short-time asymptotic expansions of the heat kernel under general timehomogenous local volatility and local-stochastic volatility models in finance, which include Heston (Heston (1993)) and (λ-)SABR models (Hagan et.al. (2002), Labordere (2008)) as special cases. Some numerical examples are shown.
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Bibliographic InfoPaper provided by CIRJE, Faculty of Economics, University of Tokyo in its series CIRJE F-Series with number CIRJE-F-842.
Length: 35 pages
Date of creation: Mar 2012
Date of revision:
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This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-02-27 (All new papers)
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