{"title":"A Robust Numerical Simulation of a Fractional Black–Scholes Equation for Pricing American Options","authors":"S. M. Nuugulu, F. Gideon, K. C. Patidar","doi":"10.1007/s44198-024-00207-y","DOIUrl":null,"url":null,"abstract":"<p>After the discovery of fractal structures of financial markets, fractional partial differential equations (fPDEs) became very popular in studying dynamics of financial markets. Available research results involves two key modelling aspects; firstly, derivation of tractable asset pricing models, those that closely reflects the actual dynamics of financial markets. Secondly, the development of robust numerical solution methods. Often times, most the effective models are of a nonlinear nature, and as such, reliable analytical solution methods are seldomly available. On the other hand, the accurate value of American options strongly lies on the unknown free boundaries associated with these types of derivative contracts. The free boundaries emanates from the flexibility of the early exercise features with American options. To the best of our knowledge, the approach of pricing American options under the fractional calculus framework has not been extensively explored in literature, and an obvious wider research gap still exist on the design of robust solution methods for pricing American option problems formulated under the fractional calculus framework. Therefore, this paper serve to propose a robust numerical scheme for solving time-fractional Black–Scholes PDEs for pricing American put option problems. The proposed scheme is based on the front-fixing algorithm, under which the early exercise boundaries are transformed into fixed boundaries, allowing for a simultaneous computation of optimal exercise boundaries and their corresponding fair premiums. Results herein indicate that, the proposed numerical scheme is consistent, stable, convergent with order <span>\\({\\mathcal {O}}(h^2,k)\\)</span>, and also does guarantee positivity of solutions under all possible market conditions.\n</p>","PeriodicalId":48904,"journal":{"name":"Journal of Nonlinear Mathematical Physics","volume":null,"pages":null},"PeriodicalIF":1.4000,"publicationDate":"2024-06-20","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":"0","resultStr":null,"platform":"Semanticscholar","paperid":null,"PeriodicalName":"Journal of Nonlinear Mathematical Physics","FirstCategoryId":"101","ListUrlMain":"https://doi.org/10.1007/s44198-024-00207-y","RegionNum":4,"RegionCategory":"物理与天体物理","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":null,"EPubDate":"","PubModel":"","JCR":"Q2","JCRName":"MATHEMATICS, APPLIED","Score":null,"Total":0}
引用次数: 0
Abstract
After the discovery of fractal structures of financial markets, fractional partial differential equations (fPDEs) became very popular in studying dynamics of financial markets. Available research results involves two key modelling aspects; firstly, derivation of tractable asset pricing models, those that closely reflects the actual dynamics of financial markets. Secondly, the development of robust numerical solution methods. Often times, most the effective models are of a nonlinear nature, and as such, reliable analytical solution methods are seldomly available. On the other hand, the accurate value of American options strongly lies on the unknown free boundaries associated with these types of derivative contracts. The free boundaries emanates from the flexibility of the early exercise features with American options. To the best of our knowledge, the approach of pricing American options under the fractional calculus framework has not been extensively explored in literature, and an obvious wider research gap still exist on the design of robust solution methods for pricing American option problems formulated under the fractional calculus framework. Therefore, this paper serve to propose a robust numerical scheme for solving time-fractional Black–Scholes PDEs for pricing American put option problems. The proposed scheme is based on the front-fixing algorithm, under which the early exercise boundaries are transformed into fixed boundaries, allowing for a simultaneous computation of optimal exercise boundaries and their corresponding fair premiums. Results herein indicate that, the proposed numerical scheme is consistent, stable, convergent with order \({\mathcal {O}}(h^2,k)\), and also does guarantee positivity of solutions under all possible market conditions.
期刊介绍:
Journal of Nonlinear Mathematical Physics (JNMP) publishes research papers on fundamental mathematical and computational methods in mathematical physics in the form of Letters, Articles, and Review Articles.
Journal of Nonlinear Mathematical Physics is a mathematical journal devoted to the publication of research papers concerned with the description, solution, and applications of nonlinear problems in physics and mathematics.
The main subjects are:
-Nonlinear Equations of Mathematical Physics-
Quantum Algebras and Integrability-
Discrete Integrable Systems and Discrete Geometry-
Applications of Lie Group Theory and Lie Algebras-
Non-Commutative Geometry-
Super Geometry and Super Integrable System-
Integrability and Nonintegrability, Painleve Analysis-
Inverse Scattering Method-
Geometry of Soliton Equations and Applications of Twistor Theory-
Classical and Quantum Many Body Problems-
Deformation and Geometric Quantization-
Instanton, Monopoles and Gauge Theory-
Differential Geometry and Mathematical Physics