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Semi-Closed Form Cubature and Applications to Financial Diffusion Models

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  • Christian Bayer
  • Peter Friz
  • Ronnie Loeffen

Abstract

Cubature methods, a powerful alternative to Monte Carlo due to Kusuoka~[Adv.~Math.~Econ.~6, 69--83, 2004] and Lyons--Victoir~[Proc.~R.~Soc.\\Lond.~Ser.~A 460, 169--198, 2004], involve the solution to numerous auxiliary ordinary differential equations. With focus on the Ninomiya-Victoir algorithm~[Appl.~Math.~Fin.~15, 107--121, 2008], which corresponds to a concrete level $5$ cubature method, we study some parametric diffusion models motivated from financial applications, and exhibit structural conditions under which all involved ODEs can be solved explicitly and efficiently. We then enlarge the class of models for which this technique applies, by introducing a (model-dependent) variation of the Ninomiya-Victoir method. Our method remains easy to implement; numerical examples illustrate the savings in computation time.

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  • Christian Bayer & Peter Friz & Ronnie Loeffen, 2010. "Semi-Closed Form Cubature and Applications to Financial Diffusion Models," Papers 1009.4818, arXiv.org.
    • Handle: RePEc:arx:papers:1009.4818
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    References listed on IDEAS

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    1. Mariko Ninomiya & Syoiti Ninomiya, 2009. "A new higher-order weak approximation scheme for stochastic differential equations and the Runge–Kutta method," Finance and Stochastics, Springer, vol. 13(3), pages 415-443, September.
    2. Syoiti Ninomiya & Nicolas Victoir, 2008. "Weak Approximation of Stochastic Differential Equations and Application to Derivative Pricing," Applied Mathematical Finance, Taylor & Francis Journals, vol. 15(2), pages 107-121.
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    Cited by:

    1. Eva Lütkebohmert & Lydienne Matchie, 2014. "Value-At-Risk Computations In Stochastic Volatility Models Using Second-Order Weak Approximation Schemes," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 17(01), pages 1-26.

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