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Applying the Model Order Reduction method to a European option pricing model

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  • Lin, Shao-Bin
  • Chen, Chun-Da

Abstract

This paper presents a European option pricing model by applying the Model-Order-Reduction (MOR) method. A European option pricing theorem based on Black–Scholes' equation is implemented by the Finite-Difference Method (FDM). However, the numerical models generated by the FDM could be simplified through the MOR technique, which is based on the concept of an Arnoldi-based Model-Order Reduction algorithm. In terms of computational cost, the MOR models are at least 2 orders of magnitude faster than the original FDM models with a negligible compromise in accuracy.

Suggested Citation

  • Lin, Shao-Bin & Chen, Chun-Da, 2013. "Applying the Model Order Reduction method to a European option pricing model," Economic Modelling, Elsevier, vol. 33(C), pages 533-536.
    • Handle: RePEc:eee:ecmode:v:33:y:2013:i:c:p:533-536
    DOI: 10.1016/j.econmod.2013.03.014
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    References listed on IDEAS

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    1. Hutchinson, James M & Lo, Andrew W & Poggio, Tomaso, 1994. "A Nonparametric Approach to Pricing and Hedging Derivative Securities via Learning Networks," Journal of Finance, American Finance Association, vol. 49(3), pages 851-889, July.
    2. Hamid, Shaikh A. & Iqbal, Zahid, 2004. "Using neural networks for forecasting volatility of S&P 500 Index futures prices," Journal of Business Research, Elsevier, vol. 57(10), pages 1116-1125, October.
    3. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
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    Cited by:

    1. Seda Gulen & Catalin Popescu & Murat Sari, 2019. "A New Approach for the Black–Scholes Model with Linear and Nonlinear Volatilities," Mathematics, MDPI, vol. 7(8), pages 1-14, August.

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    More about this item

    Keywords

    European options; Model-Order-Reduction; Dynamical systems; Numerical linear algebra;
    All these keywords.

    JEL classification:

    • C02 - Mathematical and Quantitative Methods - - General - - - Mathematical Economics
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques

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