WIAS Preprint No. 2917, (2022)

Numerical smoothing with hierarchical adaptive sparse grids and quasi-Monte Carlo methods for efficient option pricing



Authors

  • Bayer, Christian
    ORCID: 0000-0002-9116-0039
  • Ben Hammouda, Chiheb
  • Tempone, Raúl F.

2020 Mathematics Subject Classification

  • 65C05 65D30 65D32

Keywords

  • Adaptive sparse grid quadrature, quasi-Monte Carlo, numerical smoothing, Brownian bridge, Richardson extrapolation, option pricing, Monte Carlo

Abstract

When approximating the expectation of a functional of a stochastic process, the efficiency and performance of deterministic quadrature methods, such as sparse grid quadrature and quasi-Monte Carlo (QMC) methods, may critically depend on the regularity of the integrand. To overcome this issue and reveal the available regularity, we consider cases in which analytic smoothing cannot be performed, and introduce a novel numerical smoothing approach by combining a root finding algorithm with one-dimensional integration with respect to a single well-selected variable. We prove that under appropriate conditions, the resulting function of the remaining variables is a highly smooth function, potentially affording the improved efficiency of adaptive sparse grid quadrature (ASGQ) and QMC methods, particularly when combined with hierarchical transformations (i.e., Brownian bridge and Richardson extrapolation on the weak error). This approach facilitates the effective treatment of high dimensionality. Our study is motivated by option pricing problems, and our focus is on dynamics where the discretization of the asset price is necessary. Based on our analysis and numerical experiments, we show the advantages of combining numerical smoothing with the ASGQ and QMC methods over ASGQ and QMC methods without smoothing and the Monte Carlo approach.

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