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New Unified Computational Algorithm in a High-Order Asymptotic Expansion Scheme

  • Kohta Takehara

    (Graduate School of Economics, University of Tokyo)

  • Akihiko Takahashi

    (Faculty of Economics, University of Tokyo)

  • Masashi Toda

    (Graduate School of Economics, University of Tokyo)

Registered author(s):

    An asymptotic expansion scheme in finance initiated by Kunitomo and Takahashi [6] and Yoshida [29] is a widely applicable methodology for analytic approximation of the expectation of a certain functional of diffusion processes. Mathematically, this methodology is justified by Watanabe theory([27]) in Malliavin calculus. In practical applications, it is desirable to investigate the accuracy and stability of the method especially with expansion up to high orders in situations where the underlying processes are highly volatile as seen in the recent financial markets. Although Takahashi[17], [18] and Takahashi and Takehara [20] provided explicit formulas for the expansion up to the third order, to our best knowledge a general computation scheme for an arbitraryorder expansion has not been given yet. This paper proposes two general methods for computing the conditional expectations that are powerful especially for high order expansions: The first one, as an extension of the method introduced by the preceding papers, presents a unified scheme for computation of the conditional expectations. The second one develops a new calculation algorithm for computing the coefficients of the expansion through solving a system of ordinary differential equations that is equivalent to computing the conditional expectations. To demonstrate their effectiveness, the paper gives numerical examples of the approximation for - SABR model up to the fifth order and a cross-currency Libor market model with a general stochastic volatility model of the spot foreign exchange rate up to the fourth order.

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    File URL: http://www.cirje.e.u-tokyo.ac.jp/research/dp/2010/2010cf728.pdf
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    Paper provided by CIRJE, Faculty of Economics, University of Tokyo in its series CIRJE F-Series with number CIRJE-F-728.

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    Length: 18pages
    Date of creation: Mar 2010
    Date of revision:
    Handle: RePEc:tky:fseres:2010cf728
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    1. Akihiko Takahashi & Nakahiro Yoshida, 2005. "Monte Carlo Simulation with Asymptotic Method," CIRJE F-Series CIRJE-F-335, CIRJE, Faculty of Economics, University of Tokyo.
    2. Yoshifumi Muroi, 2005. "Pricing contingent claims with credit risk: Asymptotic expansion approach," Finance and Stochastics, Springer, vol. 9(3), pages 415-427, 07.
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