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Section B

Multiscale methods for the valuation of American options with stochastic volatility

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Pages 1145-1163 | Received 23 Sep 2011, Accepted 27 Feb 2012, Published online: 24 Apr 2012
 

Abstract

This paper deals with the efficient valuation of American options. We adopt Heston's approach for a model of stochastic volatility, leading to a generalized Black–Scholes equation called Heston's equation. Together with appropriate boundary conditions, this can be formulated as a parabolic boundary value problem with a free boundary, the optimal exercise price of the option. For its efficient numerical solution, we employ, among other multiscale methods, a monotone multigrid method based on linear finite elements in space and display corresponding numerical experiments.

2010 AMS Subject Classification :

Acknowledgements

We thank Christoph Schwab, who originally pointed out the problem of stochastic volatility after completion of the papers Citation27 Citation28 dealing with MMG methods with higher order B-splines. We also thank Ernst Eberlein, Andrej Palczweski and two anonymous referees on their remarks on modelling issues concerning boundary and Feller's condition, see Remark 2.1. We express our gratitude to two anonymous referees for their useful remarks on the whole manuscript. This work was supported in part by the Deutsche Forschungsgemeinschaft (SFB 611, Universität Bonn) and the Institute for Mathematics and its Applications (IMA) at the University of Minnesota with funds provided by the National Science Foundation (NSF).

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