A novel fitted finite volume method for the Black-Scholes equation governing option pricing

Song Wang

    Research output: Contribution to journalArticle

    118 Citations (Scopus)

    Abstract

    In this paper we present a novel numerical method for a degenerate partial differential equation, called the Black-Scholes equation, governing option pricing. The method is based on a fitted finite volume spatial discretization and an implicit time stepping technique. To derive the error bounds for the spatial discretization of the method, we formulate it as a Petrov-Galerkin finite element method with each basis function of the trial space being determined by a set of two-point boundary value problems defined on element edges. Stability of the discretization is proved and an error bound for the spatial discretization is established. It is also shown that the system matrix of the discretization is an M-matrix so that the discrete maximum principle is satisfied by the discretization. Numerical experiments are performed to demonstrate the effectiveness of the method.
    Original languageEnglish
    Pages (from-to)699-720
    JournalIMA Journal of Numerical Analysis
    Volume24
    Issue number4
    DOIs
    Publication statusPublished - 2004

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