Roelof sheppard thesis

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Roelof sheppard thesis

Under these assumptions closed form solutions for the values of European call and put options are derived. In practise the assumption of constant volatility is not reasonable, since we require different values for the volatility parameter for different strikes and different expiries to match market prices.

The volatility parameter that is required in the Black-Scholes formula to reproduce market prices is called the implied volatility. This is a critical internal inconsistency, since the implied volatility of the underlying should not be dependent on the specifications of the contract.

Thus to obtain market prices of options maturing at a certain date, volatility needs to be a function of the strike. This function is the so called volatility skew or smile.

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Furthermore for a fixed strike we also need different volatility parameters to match the market prices of options maturing on different dates written on the same underlying, hence volatility is a function of both the strike and the expiry date of the derivative security.

This bivariate function is called the volatility surface. There are two prominent ways of working around this problem, namely, local volatility models and stochastic volatility models. For local volatility models the assumption of constant volatility made in Black and Scholes [] is relaxed.

It is claimed in Hagan et al. This is in contrast to the market behavior where the smile shifts to higher prices resp. The major advances in stochastic volatility models are Hull and White [], Heston [] and Hagan et al. The volatility process is no longer constant as in the Black-Scholes model nor deterministic as in the local volatility models, but is now subject to its own random process.

In the Black-Scholes world the implied volatility is the only calibration parameter that needs to be determined by information in the market.

In each of the above mentioned stochastic volatility models there is more than one unknown parameter in the processes involved. These parameters are solved by using the same backward reasoning as in the Black-Scholes model.

First closed form solutions are derived for vanilla type options. These liquidly traded options are then used to determine the unknown parameters such that the total error between the theoretical and observed prices is minimized.

Once the model is calibrated, i. In chapter 2 we derive the well known result that the price of a contingent claim in a stochastic volatility model can be represented as the solution of a two dimensional convection diffusion partial differential equation PDEwith the initial condition given by the payoff function.


In this chapter we will derive the PDEs relevant to the pricing of options in these major stochastic volatility models. In this thesis we will focus on a specific class of numerical procedures to obtain accurate approximations to the solution of the relevant PDE, called the finite difference method FDM.

In this chapter we apply the -method to a one dimensional convection diffusion equation as well as a one dimensional convection equation. We define and prove the consistency and stability of these schemes.

Roelof sheppard thesis

For each of these problems we investigate the stability of the -method by making use of von Neumann stability analysis as well as a matrix method of analysis under the maximum norm.

It is noted in chapter 3 that, strictly speaking, von Neumann stability analysis is not applicable to problems with variable coefficients or problems with non-smooth initial data.

We also investigate a procedure called exponential fitting, introduced in Duffy []. This procedure is used to improve the stability properties of the -method when it is applied to a one dimensional convection diffusion equation.


We show how exponential fitting can be used to obtain schemes that are stable under the maximum norm. In Gourlay and Morris [] extrapolation methods are applied to the one dimensional heat equation with homogenous Dirichlet boundary conditions, to obtain schemes that are second, third and fourth order accurate in time.

A huge advantage of the extrapolation schemes derived in Gourlay and Morris [] is that these schemes are L0 -stable, meaning that these schemes are able to handle discontinuous initial data.

In chapter 4 we extend these ideas to convection diffusion problems with nonzero Dirichlet boundary conditions. We also obtain a scheme that is L0 -stable and fifth order accurate in time.

In chapter 5 we extend the ideas of chapter 3 to two dimensions. We show how exponential fitting can be used to make special cases of the IMEX-method stable under the maximum norm. IMEX-schemes require the inversion of large non tri-diagonal matrices, which can be very time consuming.

There are two main FDMs that are used to work around this problem: LOD-schemes are also referred to as splitting schemes. With these schemes the original problem is rewritten as a sequence of simpler problems, each one of the simpler problems can be solved with a tri-diagonal solver.

In chapter 5 we investigate the stability and consistency of a specific LOD-scheme called the Yanenko method. We motivate boundary conditions for the Yanenko scheme that retain the tri-diagonal property of the matrices and the stability of the scheme.

For all methods in this chapter stability is investigated with von Neumann stability analysis and a matrix method of analysis under the maximum norm.Mar 23,  · Roelof Sheppard March 23, Declaration. (Signature) (Date) i Acknowledgements. I would like to thank my supervisor Dr Graeme West for proposing the topic of this thesis and for his guidance and support.

I would also like to thank my family and friends for their support during my studies. A special thanks to my mother, Elsab´, without. Heston model's PDE - stability concerns. Thread starter Yani Boshev; Start date 6/20/13; Y. Yani Boshev Please see thesis by Roelof Sheppard (does it all in detail) The FD scheme in Sheppard's thesis is unconditionally stable.

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Roelof sheppard thesis

Hyper-Real-Time Ice Simulation and Modeling Using GPGPU By c Shadi Alawneh, B. Eng., M. Eng. A Thesis Submitted to the School of Graduate Studies in Partial Ful lment of the Requirements.

Hyper-Real-Time Ice Simulation and Modeling Using GPGPU By c Shadi Alawneh, B. Eng., M. Eng. A Thesis Submitted to the School of Graduate Studies in Partial Ful lment of the Requirements. Dec 31,  · I got hammered in a seminar last evening. The Morgan-Stanley Doctor said people no longer use simple Black-Scholes setting in Wall Street.

They add in Heston Volatility Model to capture the irregular up and downs of price movement.

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