High-Order Compact Finite Difference Scheme for Option Pricing in Stochastic Volatility Models
23 Pages Posted: 23 Jul 2010 Last revised: 2 Feb 2012
Date Written: July 22, 2010
We derive a new high-order compact finite difference scheme for option pricing in stochastic volatility models. The scheme is fourth order accurate in space and second order accurate in time. Under some restrictions, theoretical results like unconditional stability in the sense of von Neumann are presented. Where the analysis becomes too involved we validate our findings by a numerical study. Numerical experiments for the European option pricing problem are presented. We observe fourth order convergence for non-smooth payoff.
Keywords: Option pricing, compact finite difference discretizations, mixed derivatives, high-order scheme
JEL Classification: C63, G13
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