Variable time-stepping hybrid finite difference methods for pricing binary options

Hongjoong Kim, Kyoung Sook Moon

Research output: Contribution to journalArticle

3 Citations (Scopus)

Abstract

Two types of new methods with variable time steps are proposed in order to valuate binary options efficiently. Type I changes adaptively the size of the time step at each time based on the magnitude of the local error, while Type II combines two uniform meshes. The new methods are hybrid finite difference methods, namely starting the computation with a fully implicit finite difference method for a few time steps for accuracy then performing a θ-method during the rest of computation for efficiency. Numerical experiments for standard European vanilla, binary, and American options show that both Type I and II variable time step methods are much more efficient than the fully implicit method or hybrid methods with uniform time steps.

Original languageEnglish
Pages (from-to)413-426
Number of pages14
JournalBulletin of the Korean Mathematical Society
Volume48
Issue number2
DOIs
Publication statusPublished - 2011 Apr 29

Fingerprint

Time Stepping
Difference Method
Pricing
Finite Difference
Binary
Type II error
American Options
Implicit Method
Hybrid Method
Numerical Experiment
Mesh

Keywords

  • American options
  • Binary options
  • Hybrid finite difference method
  • Option pricing
  • Variable time steps

ASJC Scopus subject areas

  • Mathematics(all)

Cite this

Variable time-stepping hybrid finite difference methods for pricing binary options. / Kim, Hongjoong; Moon, Kyoung Sook.

In: Bulletin of the Korean Mathematical Society, Vol. 48, No. 2, 29.04.2011, p. 413-426.

Research output: Contribution to journalArticle

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