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The Exponent Expansion: An Effective Approximation of Transition Probabilities of Diffusion Processes and Pricing Kernels of Financial Derivatives


  • Luca Capriotti


A computational technique borrowed from the physical sciences is introduced to obtain accurate closed-form approximations for the transition probability of arbitrary diffusion processes. Within the path integral framework the same technique allows one to obtain remarkably good approximations of the pricing kernels of financial derivatives. Several examples are presented, and the application of these results to increase the efficiency of numerical approaches to derivative pricing is discussed.

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  • Luca Capriotti, 2006. "The Exponent Expansion: An Effective Approximation of Transition Probabilities of Diffusion Processes and Pricing Kernels of Financial Derivatives," Papers physics/0602107,
  • Handle: RePEc:arx:papers:physics/0602107

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    Cited by:

    1. Pagliarani, Stefano & Pascucci, Andrea, 2011. "Analytical approximation of the transition density in a local volatility model," MPRA Paper 31107, University Library of Munich, Germany.
    2. Andrzej Daniluk & Rafał Muchorski, 2016. "Approximations Of Bond And Swaption Prices In A Black–Karasiński Model," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 19(03), pages 1-32, May.
    3. Zuzana Buckova & Beata Stehlikova & Daniel Sevcovic, 2016. "Numerical and analytical methods for bond pricing in short rate convergence models of interest rates," Papers 1607.04968,
    4. Andrzej Daniluk & Rafa{l} Muchorski, 2015. "Approximations of Bond and Swaption Prices in a Black-Karasi\'{n}ski Model," Papers 1506.00697,

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