Finite Volume Method for Pricing European and American Options under Jump-Diffusion Models

Abstract

A class of finite volume methods is developed for pricing either European or American options under jump-diffusion models based on a linear finite element space. An easy to implement linear interpolation technique is derived to evaluate the integral term involved, and numerical analyses show that the full discrete system matrices are M-matrices. For European option pricing, the resulting dense linear systems are solved by the generalised minimal residual (GMRES) method; while for American options the resulting linear complementarity problems (LCP) are solved using the modulus-based successive overrelaxation (MSOR) method, where the $H_+$-matrix property of the system matrix guarantees convergence. Numerical results are presented to demonstrate the accuracy, efficiency and robustness of these methods.