Applications of Malliavin Calculus to Monte Carlo Methods in Finance
Posted: 21 Oct 1999
This paper presents an original probabilistic method for the numerical computations of Greeks (i.e. price sensitivities) in finance. Our approach is based on the integration-by-parts formula, which lies at the core of the theory of variational stochastic calculus, as developed in the Malliavin calculus. The Greeks formulae, both with respect to initial conditions and for smooth perturbations of the local volatility, are provided for general discontinuous path-dependent payoff functionals of multidimensional diffusion processes. We illustrate the results by applying the formula to exotic European options in the framework of the Black and Scholes model. Our method is compared to the Monte Carlo finite difference approach and turns out to be very efficient in the case of discontinuous payoff functionals.
JEL Classification: G13, C63
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