Introduction to Fast Fourier Transform in Finance
Cass Business School
February 20, 2006
Cass Business School Research Paper
The Fourier transform is an important tool in Financial Economics. It delivers real time pricing while allowing for a realistic structure of asset returns, taking into account excess kurtosis and stochastic volatility. Fourier transform is also rather abstract and therefore off-putting to many practitioners.
The purpose of this paper is to explain the working of the fast Fourier transform in the familiar binomial option pricing model. We argue that a good understanding of FFT requires no more than some high school mathematics and familiarity with roulette, bicycle wheel, or a similar circular object divided into equally sized segments. The returns to such a small intellectual investment are overwhelming.
Number of Pages in PDF File: 29
Keywords: Fast Fourier transform, option pricing, binomial lattice, chirp-z transform
JEL Classification: C63, G12
Date posted: June 29, 2004