Journal of Computational Finance

Convergence remedies for non-smooth payoffs in option pricing

David M. Pooley, Kenneth R.Vetzal, Peter A. Forsyth


Discontinuities in the payoff function (or its derivatives) can cause inaccuracies for numerical schemes when financial contracts are priced. In particular, large errors may occur in the estimation of the hedging parameters. Three methods of dealing with discontinuities are discussed in this article: averaging the initial data, shifting the grid, and a projection method. By themselves, these techniques are not sufficient to restore expected behavior. However, when combined with a special time-stepping method, high accuracy is achieved. Examples are provided for one- and two-factor option pricing problems.

Sorry, our subscription options are not loading right now

Please try again later. Get in touch with our customer services team if this issue persists.

New to View our subscription options

You need to sign in to use this feature. If you don’t have a account, please register for a trial.

Sign in
You are currently on corporate access.

To use this feature you will need an individual account. If you have one already please sign in.

Sign in.

Alternatively you can request an individual account here