Pricing Barrier Options and Credit Default Swaps (CDS) in Spectrally One-Sided Levy Models: The Parabolic Laplace Inversion Method

34 Pages Posted: 5 Nov 2013

See all articles by Mitya Boyarchenko

Mitya Boyarchenko

University of Michigan - Department of Mathematics

Sergei Levendorskii

Calico Science Consulting

Date Written: October 31, 2013

Abstract

Recently, the advantages of conformal deformations of the contours of integration in pricing formulas were demonstrated in the context of wide classes of Levy models and the Heston model. In the present paper we construct efficient conformal deformations of the contours of integration in the pricing formulas for barrier options and CDS in the setting of spectrally one-sided Levy models, taking advantage of Rogers's trick (J. Appl. Prob. 2000) that greatly simplifies calculation of the Wiener-Hopf factors. We extend the trick to wide classes of Levy processes of infinite variation with zero diffusion component. In the resulting formulas (both in the finite variation and the infinite variation cases), we make quasi-parabolic deformations as in S. Boyarchenko and Levendorskii (IJTAF 2013), which greatly increase the rate of convergence of the integrals. We demonstrate that the proposed method is more accurate than the standard realization of Laplace inversion in many cases. We also exhibit examples in which the standard realization is so unstable that it cannot be used for any choice of the error control parameters.

Keywords: Spectrally one-sided Levy processes, Wiener-Hopf factorization, barrier options, credit default swaps, parabolic inverse Laplace transform, parabolic inverse Fourier transform

JEL Classification: C63, G13

Suggested Citation

Boyarchenko, Mitya and Levendorskii, Sergei Z., Pricing Barrier Options and Credit Default Swaps (CDS) in Spectrally One-Sided Levy Models: The Parabolic Laplace Inversion Method (October 31, 2013). Available at SSRN: https://ssrn.com/abstract=2348194 or http://dx.doi.org/10.2139/ssrn.2348194

Mitya Boyarchenko

University of Michigan - Department of Mathematics ( email )

530 Church Street
2074 East Hall
Ann Arbor, MI 48109
United States

Sergei Z. Levendorskii (Contact Author)

Calico Science Consulting ( email )

Austin, TX
United States

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