Comparison of the analytical approximation formula and Newton’s method for solving a class of nonlinear Black-Scholes parabolic equations. (English) Zbl 1330.91183
Summary: Market illiquidity, feedback effects, presence of transaction costs, risk from unprotected portfolio and other nonlinear effects in PDE-based option pricing models can be described by solutions to the generalized Black-Scholes parabolic equation with a diffusion term nonlinearly depending on the option price itself. In this paper, different linearization techniques such as Newton’s method and the analytic asymptotic approximation formula are adopted and compared for a wide class of nonlinear Black-Scholes equations including, in particular, the market illiquidity model and the risk-adjusted pricing model. Accuracy and time complexity of both numerical methods are compared. Furthermore, market quotes data was used to calibrate model parameters.
MSC:
91G60 | Numerical methods (including Monte Carlo methods) |
65M06 | Finite difference methods for initial value and initial-boundary value problems involving PDEs |
35C20 | Asymptotic expansions of solutions to PDEs |
35K55 | Nonlinear parabolic equations |
35Q91 | PDEs in connection with game theory, economics, social and behavioral sciences |