Journal of Computational Finance

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A reduced basis method for parabolic partial differential equations with parameter functions and application to option pricing

Antonia Mayerhofer and Karsten Urban

  • A reduced Basis space-time variational approach for parametric parabolic partial differential equations having coefficient parameters and a variable initial condition is introduced.
  • Feasibility and efficiency are demonstrated.

ABSTRACT

We consider the Heston model as an example of a parameterized parabolic partial differential equation. A space-time variational formulation is derived that allows for parameters in the coefficients (for calibration) and enables us to choose the initial condition (for option pricing) as a parameter function. A corresponding discretization in space and time for the initial condition are introduced. Finally, we present a novel reduced basis method that is able to use the initial condition of the parabolic partial differential equation as a parameter (function). The corresponding numerical results are shown.

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