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    MA473 Lab8

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    MA473 Lab8

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    sherlocktemp19
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    MA473_Lab8

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    MA473 Lab8

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    DEPARTMENT OF MATHEMATICS

    IIT GUWAHATI
    MA 473 Computational Finance Lab – VIII Date: 24.09.2024
    Consider the following Black-Scholes PDE for European call:
    ∂V 1 2 2 ∂2V ∂V


     + σ S 2
    + (r − δ)S − rV = 0, (0, ∞) × (0, T ], T > 0
     ∂t 2 ∂S ∂S



    V (S, t) = 0, for S = 0,
    V (S, t) = S − Ke−r(T −t) , for S → ∞






    with the terminal condition V (S, T ) = max(S − K, 0).
    With the following transformation

    2τ 2r 2(r − δ)
    S = Kex , t = T − 2 , q := 2 , q δ := ,


    σ σ σ2




      
     2τ
    V (s, t) = V Kex , T − 2 =: v(x, τ ), and

     σ
        

     1 1 2
     v(x, τ ) =: K exp − (q δ − 1)x − (q δ − 1) + q τ y(x, τ ),


    2 4
    the above Black-Scholes PDE becomes the following 1-D heat conduction parabolic PDE:
    ∂2y

    ∂y
    = , x ∈ R, τ ≥ 0,


    ∂τ ∂x2






    y(x, 0) = max exp( x2 (qδ + 1)) − exp( x2 (qδ − 1)), 0 , x ∈ R,
     





     y(x, τ ) = 0, for x → −∞,


    y(x, τ ) = exp 12 (qδ + 1)x + 14 (qδ + 1)2 τ for x → ∞.
     

    Solve the transformed PDE by the following finite element methods (FEMs):
    (i) Piecewise-linear basis functions with the trapezoidal rule for the numerical quadratures and the
    Crank-Nicolson scheme (in time).
    (ii) Piecewise-linear basis functions with the Simpson’s rule for the numerical quadratures and the
    Crank-Nicolson scheme (in time).
    The values of the parameters are T = 1, K = 10, r = 0.06, σ = 0.3 and δ = 0.

    The output files should contain the following for above problem:
    a) Plot the numerical solution at the final time level.
    b) Draw the surface plot of the numerical solution.
    c) Use the double-mesh principle to calculate the L2 −norm errors. Use the log-log plot to show the
    order of convergence.

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