Adaptive finite differences and IMEX time-stepping to price options under Bates model

Abstract

In this paper, we consider numerical pricing of European and American options under the Bates model, a model which gives rise to a partial-integro differential equation. This equation is discretized in space using adaptive finite differences while an IMEX scheme is employed in time. The sparse linear systems of equations in each time-step are solved using an LU-decomposition and an operator splitting technique is employed for the linear complementarity problems arising for American options. The integral part of the equation is treated explicitly in time which means that we have to perform matrix-vector multiplications each time-step with a matrix with dense blocks. These multiplications are accomplished through fast Fourier transforms. The great performance of the method is demonstrated through numerical experiments.

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