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On solutions of a partial integro-differential equation in Bessel potential spaces with applications in option pricing models

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Abstract

In this paper we focus on qualitative properties of solutions to a nonlocal nonlinear partial integro-differential equation (PIDE). Using the theory of abstract semilinear parabolic equations we prove existence and uniqueness of a solution in the scale of Bessel potential spaces. Our aim is to generalize known existence results for a wide class of Lévy measures including with a strong singular kernel. As an application we consider a class of PIDEs arising in the financial mathematics. The classical linear Black–Scholes model relies on several restrictive assumptions such as liquidity and completeness of the market. Relaxing the complete market hypothesis and assuming a Lévy stochastic process dynamics for the underlying stock price process we obtain a model for pricing options by means of a PIDE. We investigate a model for pricing call and put options on underlying assets following a Lévy stochastic process with jumps. We prove existence and uniqueness of solutions to the penalized PIDE representing approximation of the linear complementarity problem arising in pricing American style of options under Lévy stochastic processes. We also present numerical results and comparison of option prices for various Lévy stochastic processes modelling underlying asset dynamics.

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Acknowledgements

This research was supported by the project CEMAPRE MULTI/00491 financed by FCT/MEC through national funds and the Slovak research Agency Project VEGA 1/0062/18.

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Authors and Affiliations

  1. ISEG, University of Lisbon, Rua de Quelhas 6, 1200-781, Lisbon, Portugal

    José M. T. S. Cruz

  2. Comenius University in Bratislava, Mlynská dolina, 84248, Bratislava, Slovakia

    Daniel Ševčovič

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  1. José M. T. S. Cruz
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  2. Daniel Ševčovič
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Correspondence to Daniel Ševčovič.

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Cruz, J.M.T.S., Ševčovič, D. On solutions of a partial integro-differential equation in Bessel potential spaces with applications in option pricing models. Japan J. Indust. Appl. Math. 37, 697–721 (2020). https://doi.org/10.1007/s13160-020-00414-2

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  • DOI: https://doi.org/10.1007/s13160-020-00414-2

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