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Introduction
Approximation error
with Stochastic Differential
Stochastic Taylor exp.
Numerical methods
Equations
Algorithm
Monte Carlo
Introduction Study linear SDE
Approximation error
dXt = Xt dt + Xt dWt
Stochastic Taylor exp.
Numerical methods
Algorithm
with initial value X0 for t = 0. This SDE has
analytical solution
Xt = X0 e (( 2 )t+ Wt )
1
2 (2)
Let f 2 C 1(R) )
d
dt f (Xt ) = [chainrule] = @@x f (Xt ) dX t
(requires f 2 C 2 ) )
Approximation error
Stochastic Taylor exp.
Numerical methods
Algorithm
t R n s R o
f (Xt ) = f (Xt0 ) + t0 f˜(Xt0 ) + t0 Lf˜(Xz )dz ds =
Rt Rt Rs
= f (Xt0 ) + f˜(Xt0 ) t0 ds + t0 t0 Lf˜(Xz )dzds =
Rt Rs
= f (Xt0 ) + Lf (Xt0 )(t t0 ) + t0 t0 L2 f (Xz )dzds
Z t Z t
f (Xt ) = f (Xt0 ) + L0 f (Xs )ds + L1 f (Xs )dWs :
t0 t0
(5)
Monte Carlo methods, Lina von Sydow, (9 : 18)
Now let f = x )
Z t Z t
Xt = X0 + a(Xs )ds + b(Xs )dWs (6)
t0 t0
with
L0 a = aa0 + 12 b 2 a00 ;
L1 a = ba0 ;
L0 b = ab0 + 21 b 2 b 00 ;
L1 b = bb0 :
Monte Carlo methods, Lina von Sydow, (10 : 18)
Summarizing we get
Z t Z t
Xt = Xt0 + a(Xt0 ) ds + b(Xt0 ) dWs + R
Monte Carlo t0 t0
Introduction
Approximation error
with
Stochastic Taylor exp.
Numerical methods
Algorithm Rt Rs Rt Rs
R = t0 t0 L0 a(Xz )dzds + t0 t0 L1 a(Xz )dWz ds+
Rt Rs Rt Rs
+ t0 t0 L0 b(Xz )dzdWz + t0 t0 L1 b(Xz )dWz dWs :
Rt Rt
Xt = Xt0 + a(Xt0 ) t0 ds + b(Xt0 ) t0 dWs +
Rt R
+ b(Xt0 )b 0 (Xt0 ) t0 t0 dWz dWs + R̃ :
Monte Carlo
Introduction Milstein:
Approximation error
Stochastic Taylor exp.
Numerical methods
yj+1 = yj + a(yj )∆t + b(yj )∆W +
+ 12 b(yj )b 0 (yj ) (∆W )2 ∆t
Algorithm
(7)
p
∆W = Z ∆t Z ' N (0; 1):
Milstein is strongly convergent with order 1.
b 0 (y )b(y ) ∆W + O(∆t)
Approximation error
Stochastic Taylor exp.
Numerical methods
Algorithm
)
b 0 (y )b(y ) b(y +∆y ) b(y )
∆W =
p
p
b(y +a ∆t+b ∆t) b(y )
∆t
1 X
N
Ê (V (ST ; T )) = (V (ST ; T ))k :
N
k=1