Journal
APPLIED NUMERICAL MATHEMATICS
Volume 61, Issue 7, Pages 821-831Publisher
ELSEVIER SCIENCE BV
DOI: 10.1016/j.apnum.2011.02.002
Keywords
American option; Jump-diffusion model; Finite difference method; Linear complementarity problem; Iterative method
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Funding
- Academy of Finland [121271, 129690]
- Academy of Finland (AKA) [129690, 121271, 129690, 121271] Funding Source: Academy of Finland (AKA)
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We propose an iterative method for pricing American options under jump-diffusion models. A finite difference discretization is performed on the partial integro-differential equation, and the American option pricing problem is formulated as a linear complementarity problem (LCP). Jump-diffusion models include an integral term, which causes the resulting system to be dense. We propose an iteration to solve the LCPs efficiently and prove its convergence. Numerical examples with Kou's and Merton's jump-diffusion models show that the resulting iteration converges rapidly. (C) 2011 IMACS. Published by Elsevier B.V. All rights reserved.
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