Numerical schemes for pricing Asian options under state-dependent regime-switching jump–diffusion models

• Published in: Computers & mathematics with applications (1987) 2016-01, Vol.71 (1), p.443-458
• Main Authors: Dang, Duy-Minh, Nguyen, Duy, Sewell, Granville
• Format: Article
• Language: English
• Subjects: Approximation; Asian; Asian options; Complex systems; Computer simulation; Construction; Jump–diffusion; Mathematical analysis; Mathematical models; Parallel computing; Pricing; Regime-switching; System of partial integro-differential equations
• ISSN: 0898-1221; 1873-7668
• DOI: 10.1016/j.camwa.2015.12.017

We study the pricing problem of Asian options when the underlying asset price follows a very general state-dependent regime-switching jump–diffusion process via a partial differential equation approach. Under this model, the price of the option can be obtained by solving a highly complex system of coupled two-dimensional parabolic partial integro-differential equations (PIDEs). We prove existence of the solution to this system of PIDEs by the method of upper and lower solutions via constructing a monotonic sequence of approximating solutions whose limit is a strong solution of the PIDE system. We then propose several numerical schemes for solving the system of PIDEs. One of the proposed schemes is built upon the constructive proof, hence its results are provably convergent to the solution of the system of PIDEs. We illustrate the accuracy of the proposed methods by several numerical examples.