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A EUROPEAN OPTION GENERAL FIRST-ORDER ERROR FORMULA

Part of: Mathematical finance Applications

Published online by Cambridge University Press:  04 September 2013

GUILLAUME LEDUC
GUILLAUME LEDUC*
Affiliation:
American University of Sharjah, PO Box 26666, Sharjah, UAE email [email protected]
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Abstract

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We study the value of European security derivatives in the Black–Scholes model when the underlying asset $\xi $ is approximated by random walks ${\xi }^{(n)} $. We obtain an explicit error formula, up to a term of order $ \mathcal{O} ({n}^{- 3/ 2} )$, which is valid for general approximating schemes and general payoff functions. We show how this error formula can be used to find random walks ${\xi }^{(n)} $ for which option values converge at a speed of $ \mathcal{O} ({n}^{- 3/ 2} )$.

Keywords

European optionsapproximation schemeerror formulaBlack–Scholes

MSC classification

Secondary: 91G20: Derivative securities 91G60: Numerical methods (including Monte Carlo methods) 62P05: Applications to actuarial sciences and financial mathematics
Type
Research Article
Information
The ANZIAM Journal , Volume 54 , Issue 4 , April 2013 , pp. 248 - 272
Copyright
Copyright ©2013 Australian Mathematical Society 

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