Journal of Computational Finance

Risk.net

Efficient solution of backward jump-diffusion partial integro-differential equations with splitting and matrix exponentials

Andrey Itkin

  • A unified approach for solving jump-diffusion partial integro-differential equations is proposed.
  • The jump integral term is treated as a pseudo-differential operator.
  • Appropriate first- and second-order discrete approximations to these operators are presented, resulting in an unconditionally stable time discretization and a preservation of the solution's positivity.

ABSTRACT

We propose a new, unified approach to solving jump-diffusion partial integrodifferential equations (PIDEs), which often appear in mathematical finance. Our method consists of the following steps. First, a second-order operator splitting on financial processes (diffusion and jumps) is applied to these PIDEs. To solve the diffusion equation, we use standard finite-difference methods, which for multidimensional problems could also include splitting on various dimensions. For the jump part, we transform the jump integral into a pseudo-differential operator. Then, for various jump models, we show how to construct an appropriate first- and secondorder approximation on a grid that supersets the grid we used for the diffusion part. These approximations make the scheme unconditionally stable in time and preserve the positivity of the solution, which is computed either via a matrix exponential or via a Padé approximation of the matrix exponent.Various numerical experiments are provided to justify these results.

To continue reading...

You need to sign in to use this feature. If you don’t have a Risk.net 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 indvidual account here: