Article ID: | iaor20133288 |
Volume: | 235 |
Issue: | 13 |
Start Page Number: | 3921 |
End Page Number: | 3931 |
Publication Date: | May 2011 |
Journal: | Journal of Computational and Applied Mathematics |
Authors: | Li Leong Kwan, Zhou Hong Jun, Yiu Ka Fai Cedric |
Keywords: | simulation |
In this paper, American put options on zero‐coupon bonds are priced under a single factor model of short‐term rate. The linear complementarity problem of the option value is solved numerically by a penalty method, by which the problem is transformed into a nonlinear PDE by adding a power penalty term. The solution of the penalized problem converges to that of the original problem. A numerical scheme is established by using the finite volume method and the corresponding stability and convergence are discussed. Numerical results are presented to show the usefulness of the method.