A Hybrid Monte Carlo and Finite Difference Method for Option Pricing

Darae Jeong, Minhyun Yoo, Changwoo Yoo, Junseok Kim

Research output: Contribution to journalArticle

1 Citation (Scopus)

Abstract

We propose an accurate, efficient, and robust hybrid finite difference method, with a Monte Carlo boundary condition, for solving the Black–Scholes equations. The proposed method uses a far-field boundary value obtained from a Monte Carlo simulation, and can be applied to problems with non-linear payoffs at the boundary location. Numerical tests on power, powered, and two-asset European call option pricing problems are presented. Through these numerical simulations, we show that the proposed boundary treatment yields better accuracy and robustness than the most commonly used linear boundary condition. Furthermore, the proposed hybrid method is general, which means it can be applied to other types of option pricing problems. In particular, the proposed Monte Carlo boundary condition algorithm can be implemented easily in the code of the existing finite difference method, with a small modification.

Original languageEnglish
Pages (from-to)1-14
Number of pages14
JournalComputational Economics
DOIs
Publication statusAccepted/In press - 2017 Aug 30

Fingerprint

Finite difference method
Boundary conditions
Costs
Computer simulation
Option pricing
Monte Carlo simulation
Hybrid method
Black-Scholes equation
Call option
Assets
Robustness
Numerical simulation

Keywords

  • Black–Scholes equation
  • Boundary condition
  • Finite difference method
  • Monte Carlo simulation
  • Option pricing

ASJC Scopus subject areas

  • Economics, Econometrics and Finance (miscellaneous)
  • Computer Science Applications

Cite this

A Hybrid Monte Carlo and Finite Difference Method for Option Pricing. / Jeong, Darae; Yoo, Minhyun; Yoo, Changwoo; Kim, Junseok.

In: Computational Economics, 30.08.2017, p. 1-14.

Research output: Contribution to journalArticle

Jeong, Darae ; Yoo, Minhyun ; Yoo, Changwoo ; Kim, Junseok. / A Hybrid Monte Carlo and Finite Difference Method for Option Pricing. In: Computational Economics. 2017 ; pp. 1-14.
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