Small Dimension PDE for Discrete Asian Options

LSE Working Paper

20 Pages Posted: 3 Apr 2001  

Eric Benhamou

Université Paris Est - Université Paris Est-Creteil

Alexandre Duguet

BNP - Paribas

Date Written: May 2000

Abstract

This paper presents an efficient method for pricing discrete Asian options. Its contribution to the existing literature consists in targeting at smile and non proportional dividend effects. Using an homogeneity property, we show how to reduce an n +1 dimensional problem to a 2 or 3 dimensional one. We derive a PDE for the Asian option and solve it with the standard Crank Nicholson method. The dimension reduction imposes us to interpolate and extrapolate our conditional price at each fixing date. Within a deterministic volatility structure consistent with the smile, the homogeneity property is roughly conserved, thanks to a vega correction term. This allows us to stay in a two dimensional framework as in the Black Scholes case. We examine different numerical specifications of our finite difference (interpolation method, grid boundaries, time and space steps) as well as the extension to the case of non proportional discrete dividends, using a jump condition. We benchmark our results with Quasi Monte-Carlo simulation and a multi-dimensional PDE.

JEL Classification: G12, G13

Suggested Citation

Benhamou, Eric and Duguet, Alexandre, Small Dimension PDE for Discrete Asian Options (May 2000). LSE Working Paper. Available at SSRN: https://ssrn.com/abstract=265273 or http://dx.doi.org/10.2139/ssrn.265273

Eric Benhamou (Contact Author)

Université Paris Est - Université Paris Est-Creteil ( email )

61 avenue du Général de Gaulle
Créteil, 940000
France

Alexandre Duguet

BNP - Paribas ( email )

16 Boulevard des Italiens
Paris, 75009
France

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