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Convergence Remedies For Non-Smooth Payoffs in Option Pricing

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D. M. Pooley,
K. R. Vetzaly,
P. A. Forsythz
Discontinuities in the payo function (or its derivatives) can cause inaccuracies for numerical schemes when pricing nancial contracts. In particular, large errors may occur in the estimation of the hedging parameters. Three methods of dealing with discontinuities are discussed in this paper: averaging the initial data, shifting the grid, and a projection method. By themselves, these techniques are not sucient to restore expected behaviour. However, when combined with a special timestepping method, high accuracy is achieved. Examples are provided for one and two factor option pricing problems.

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Submitter: vanna
Publisher: Not Specified
Published: Sun, 29-Jul-2007
ICRA: EC - Early Childhood
linked: 614 times

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