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A master equation approach to option pricing

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  • Daniel Faller
  • Francesco Petruccione

Abstract

A master equation approach to the numerical solution of option pricing models is developed. The basic idea of the approach is to consider the Black--Scholes equation as the macroscopic equation of an underlying mesoscopic stochastic option price variable. The dynamics of the latter is constructed and formulated in terms of a master equation. The numerical efficiency of the approach is demonstrated by means of stochastic simulation of the mesoscopic process for both European and American options.

Suggested Citation

  • Daniel Faller & Francesco Petruccione, 2002. "A master equation approach to option pricing," Papers cond-mat/0209522, arXiv.org.
    • Handle: RePEc:arx:papers:cond-mat/0209522
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