A master equation approach to option pricing

Details A master equation approach to option pricing A master equation approach to option pricing

2002-09-23

arxiv.org/abs/cond-mat/0209522v1

Physics

Condensed Matter

Statistical Mechanics

19 pages, 6 figures, to be published in Physica A

Scientific paper

10.1016/S0378-4371(02)01530-3

A master equation approach to the numerical solution of option pricing models is developed. The basic idea of the approach is to consider the Black--Scholes equation as the macroscopic equation of an underlying mesoscopic stochastic option price variable. The dynamics of the latter is constructed and formulated in terms of a master equation. The numerical efficiency of the approach is demonstrated by means of stochastic simulation of the mesoscopic process for both European and American options.

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