Adjoints and Automatic (Algorithmic) Differentiation in Computational Finance

25 Pages Posted: 2 May 2011 Last revised: 12 Sep 2011

Date Written: September 12, 2011

Abstract

Two of the most important areas in computational finance: Greeks and, respectively, calibration, are based on efficient and accurate computation of a large number of sensitivities. This paper gives an overview of adjoint and automatic differentiation (AD), also known as algorithmic differentiation, techniques to calculate these sensitivities. When compared to finite difference approximation, this approach can potentially reduce the computational cost by several orders of magnitude, with sensitivities accurate up to machine precision. AAD can be applied in conjunction with any analytical or numerical method (finite difference, Monte Carlo, etc) used for pricing, preserving the numerical properties of the original method. Examples and a literature survey are included.

Keywords: Adjoint, Automatic Differentiation, Algorithmic Differentiation, Monte Carlo, Greeks, Calibration, computational efficiency

JEL Classification: C15, C61, C63, G12, G13

Suggested Citation

Homescu, Cristian, Adjoints and Automatic (Algorithmic) Differentiation in Computational Finance (September 12, 2011). Available at SSRN: https://ssrn.com/abstract=1828503 or http://dx.doi.org/10.2139/ssrn.1828503

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