Fast drift approximated pricing in the BGM model
AbstractThis paper shows that the forward rates process discretized by a single time step together with a separability assumption on the volatility function allows for representation by a low-dimensional Markov process. This in turn leads to e±cient pricing by for example finite differences. We then develop a discretization based on the Brownian bridge especially designed to have high accuracy for single time stepping. The scheme is proven to converge weakly with order 1. We compare the single time step method for pricing on a grid with multi step Monte Carlo simulation for a Bermudan swaption, reporting a computational speed increase of a factor 10, yet pricing sufficiently accurate.
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Bibliographic InfoPaper provided by EconWPA in its series Finance with number 0502005.
Length: 37 pages
Date of creation: 11 Feb 2005
Date of revision:
Note: Type of Document - pdf; pages: 37
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BGM model; predictor-corrector; Brownian bridge; Markov processes; separability; Feynman-Kac; Bermudan swaption;
Find related papers by JEL classification:
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
This paper has been announced in the following NEP Reports:
- NEP-ALL-2005-04-16 (All new papers)
- NEP-CMP-2005-04-16 (Computational Economics)
- NEP-FIN-2005-04-16 (Finance)
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