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On a semi-spectral method for pricing an option on a mean-reverting asset

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  • L. P. Bos
  • A. F. Ware
  • B. S. Pavlov

Abstract

We consider a risky asset following a mean-reverting stochastic process of the form [image omitted] We show that the (singular) diffusion equation which gives the value of a European option on S can be represented, upon expanding in Laguerre polynomials, by a tridiagonal infinite matrix. We analyse this matrix to show that the diffusion equation does indeed have a solution and truncate the matrix to give a simple, highly efficient method for the numerical calculation of the solution.

Suggested Citation

  • L. P. Bos & A. F. Ware & B. S. Pavlov, 2002. "On a semi-spectral method for pricing an option on a mean-reverting asset," Quantitative Finance, Taylor & Francis Journals, vol. 2(5), pages 337-345.
  • Handle: RePEc:taf:quantf:v:2:y:2002:i:5:p:337-345
    DOI: 10.1088/1469-7688/2/5/302
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