Black-scholes type equations [Elektronische Ressource] : mathematical analysis, parameter identification & numerical solutions / Bertram Düring

B. Düring

Informations

• Publié par: johannes_gutenberg-universitat_mainz
• Publié le: 01 janvier 2005
• Nombre de lectures: 11
• Langue: English
• Poids de l'ouvrage: 1 Mo

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Black{Scholes Type Equations:
Mathematical Analysis,
Parameter Identi cation &
Numerical Solution
Dissertation
zur Erlangung des Grades
Doktor der Naturwissenschaften
am Fachbereich Physik, Mathematik und Informatik
der Johannes Gutenberg{Universit at Mainz
Bertram During
geboren in Berlin
Mainz, Juli 2005Abstract
In this work we are concerned with the analysis and numerical solution of
Black{Scholes type equations arising in the modeling of incomplete nancial
markets and an inverse problem of determining the local volatility function
in a generalized Black{Scholes model from observed option prices.
In the rst chapter a fully nonlinear Black{Scholes equation which models
transaction costs arising in option pricing is discretized by a new high order
compact scheme. The compact scheme is proved to be unconditionally sta-
ble and non{oscillatory and is very e cien t compared to classical schemes.
Moreover, it is shown that the nite di erence solution converges locally
uniformly to the unique viscosity solution of the continuous equation.
In the next chapter we turn to the calibration problem of computing
local volatility functions from market data in a generalized Black{Scholes
setting. We follow an optimal control approach in a Lagrangian framework.
We show the existence of a global solution and study rst{ and second{order
optimality conditions. Furthermore, we propose an algorithm that is based
on a globalized sequential quadratic programming method and a primal{dual
active set strategy, and present numerical results.
In the last chapter we consider a quasilinear parabolic equation with
quadratic gradient terms, which arises in the modeling of an optimal port-
folio in incomplete markets. The existence of weak solutions is shown by
considering a sequence of approximate solutions. The main di cult y of the
1proof is to infer the strong convergence of the sequence inH . Furthermore,
we prove the uniqueness of weak solutions under a smallness condition on
the derivatives of the covariance matrices with respect to the solution, but
without additional regularity assumptions on the solution. The results are
illustrated by a numerical example.Contents
Chapter 1. Introduction 5
1.1 Mathematics and nance . . . . . . . . . . . . . . . . . . . . . 5
1.2 Basic notions and results . . . . . . . . . . . . . . . . . . . . . 6
1.3 Nonlinear Black{Scholes type equations . . . . . . . . . . . . . 19
1.4 Outline . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
Chapter 2. Option Pricing with Transaction Costs 31
2.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
2.2 The transformed problem . . . . . . . . . . . . . . . . . . . . 34
2.3 Finite di erence schemes . . . . . . . . . . . . . . . . . . . . . 35
2.4 R3C scheme . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40
2.5 Numerical study . . . . . . . . . . . . . . . . . . . . . . . . . . 48
2.6 Convergence results . . . . . . . . . . . . . . . . . . . . . . . . 54
2.7 Financial example . . . . . . . . . . . . . . . . . . . . . . . . . 60
Chapter 3. Parameter Estimation in Option Pricing 65
3.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65
3.2 The optimal control problem . . . . . . . . . . . . . . . . . . . 68
3.3 The optimization method . . . . . . . . . . . . . . . . . . . . 88
3.4 Numerical experiments . . . . . . . . . . . . . . . . . . . . . . 95
Chapter 4. Optimal Portfolio in Incomplete Markets 99
4.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99
34 Contents
4.2 Existence of solutions . . . . . . . . . . . . . . . . . . . . . . . 101
4.3 The Cauchy problem . . . . . . . . . . . . . . . . . . . . . . . 114
4.4 Uniqueness of solutions . . . . . . . . . . . . . . . . . . . . . . 117
4.5 Application and numerical example . . . . . . . . . . . . . . . 124
Bibliography 126Chapter 1
Introduction
The rst part of this introduction is thought of as a motivation for the follow-
ing. The reader interested in the scienti c results may skip the rst section
of this introduction and turn directly to the second section which features a
short overview on some basic notions and results.
1.1 Mathematics and nance
1.1.1 Financial markets and mathematical research
In mathematical research the study of nancial markets has drawn rising
attention. The modeling approaches encompass methods and techniques
from many di eren t mathematical disciplines: Stochastical and statistical
methods, deterministic and stochastic partial di eren tial equations (PDE),ds of applied functional analysis and others. In this work, we take a
PDE point of view. Hence, we will try to limit the stochastic calculus to a
minimum which is needed to understand the foundations and derivations of
the mathematical models considered. Then we investigate analytically and
numerically in{depth the resulting partial di eren tial equations.
1.1.2 Mathematical modelling
What is to be understood by mathematical modelling? The process of math-
ematical modeling usually involves the following steps:
56 1. Introduction
(i) Proper speci cation of the real problem,
(ii) Conversion into a mathematical formulation,
(iii) Analysis of the problem,
(iv) Numerical (or analytical, if possible) solution,
(v) Interpretation of the results.
If the results are unsatisfactory, the mathematical model needs to be re ned
and the cycle is repeated.
Consider a typical example, where we can identify the di eren t steps
of the above modelling scheme: In the context of nancial mathematics, a
common problem is the valuation of particular nancial contracts, so{called
nancial derivatives (i). The ‘classical’ model has been developed by Black
and Scholes and independently by Merton. Their mathematical formulation
is the Black{Scholes partial di eren tial equation (ii). Its analysis shows that
it can be transformed into the heat equation (iii), which admits an analytical
solution (iv), resulting in the famous Black{Scholes formula which has been
used by practitioners for thirty years now (v).
In this work, the focus is laid on the steps (iii) and (iv), the mathemati-
cal analysis and numerical solution, which are always complemented by short
discussions of the results. Steps (i) and (ii), the speci cation and
cal formulation of the problems, are presented in the introduction to give the
reader a basis for understanding the sources of the mathematical problems
treated later. For details on the derivation and technical points we refer to
the original works.
1.2 Basic notions and results
In this section we will introduce some basic notions as well as fundamen-
tal assumptions of the modelling, followed by a very short overview on the
classical models for two common problems in nancial mathematics, option
pricing and portfolio optimization.
1.2.1 Markets, derivatives, and options
A market is a place where buyers and sellers make transactions, directly
or via intermediaries and a nancial market is a market for the exchange of1.2. Basic notions and results 7
capital and credit. An investment is an item of value purchased for income or appreciation and hence an investor is someone making investments.
A security is an investment, other than an insurance policy or xed annuity,
issued by a corporation or other organization which o ers evidence of debt
or equity.
The nancial market can be divided into the money market, where short{
term debt securities, such as banker’s acceptances and treasury bills with a
maturity of one year or less and often 30 days or less are traded and the
capital market, where debt or equity securities are traded.
A nancial derivative is a nancial instrument whose characteristics and
value depend upon the characteristics and value of an underlying security,
typically a commodity, bond, equity or currency. Derivatives are also known
as contingent claims since their pay{o s are contingent upon the underlying.
Examples of derivatives include futures and options. Advanced investors
purchase or sell derivatives to manage the risk associated with the underlying
security, to protect against uctuations in value, or to pro t from periods of
inactivity or decline.
A future is a contract that requires delivery of a commodity, bond, cur-
rency, or stock index, at a speci ed price, on a speci ed future date. Unlike
options, futures convey an obligation to buy. The derivatives that we will be
concerned with in this work are options.
De nition 1.1 (European Call/Put option). A European Call (Put)
option is a nancial derivative that certi es the holder’s right | but not
obligation | to buy (for a call option) or sell (for a put option) a speci c
amount of an underlying security, for a xe d price E (exercise price), at a
xe d future time T (maturity or expiry).
An American option is an option which in contrast to the European option
can be exercised at any time between the purchase date and the expiration
date. Since an option securitizes a right it has a certain option value or
option price. This value, denoted byV S(t);t , depends on the priceS(t) of
the underlying and the time t. The value of a call option at maturity time
T depends on the price of the underlying at this time. There are two cases:
The underlying’s price at maturity is higher tha