Efficient pricing of commodity options with early-exercise under the Ornstein–Uhlenbeck process

We analyze the efficiency properties of a numerical pricing method based on Fourier-cosine expansions for early-exercise options. We focus on variants of Schwartzʼ model based on a mean reverting Ornstein–Uhlenbeck process, which is commonly used for modeling commodity prices. This process however d...

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Bibliographic Details
Published in:Applied numerical mathematics 2012-02, Vol.62 (2), p.91-111
Main Authors: Zhang, B., Grzelak, L.A., Oosterlee, C.W.
Format: Article
Language:English
Subjects:
Early-exercise commodity options
Efficient pricing
Error analysis
Exact sciences and technology
Fourier-cosine expansions
Mathematics
Numerical analysis
Numerical analysis. Scientific computation
Numerical methods in probability and statistics
Ornstein–Uhlenbeck process
Sciences and techniques of general use
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Summary:We analyze the efficiency properties of a numerical pricing method based on Fourier-cosine expansions for early-exercise options. We focus on variants of Schwartzʼ model based on a mean reverting Ornstein–Uhlenbeck process, which is commonly used for modeling commodity prices. This process however does not possess favorable properties for the option pricing method of interest. We therefore propose an approximation of its characteristic function, so that the Fast Fourier Transform can be applied for highest efficiency.
ISSN:0168-9274
1873-5460
DOI:10.1016/j.apnum.2011.10.005