RUBY: Fast evaluation of European options under the Merton jump diffusion

Purpose

• The package "Ruby" provides a fast method based on numerical PDEs for evaluating European put options under the Merton's jump diffusion. It uses a new modal spectral element method in the 1-D semi-unbounded space and a Crank-Nicolson Leap-frog scheme in time. The underline space module is inherited from the package "Sea".

Specifications

• Name: Ruby.
• Author: Feng Chen.
• Finishing date: 06/02/2011.
• Languages: Fortran 90, MATLAB.
• Required libraries: BLAS, LAPACK.

Simple Example

• Equation: \begin{equation} v_\tau=\frac{\sigma^2 S^2}{2}v_{SS} +(r-\lambda \kappa) Sv_S -(r+\lambda)v+\lambda\int_0^\infty v(\eta S, \tau)G(\eta)\text{d} \eta, \end{equation} where \begin{equation} (x,\tau) \in (0,\infty)\times (0,T),\quad G(\eta) = \frac{1}{\sqrt{2\pi} \delta \eta} e^{-\frac{(\ln \eta - m)^2}{2\delta^2}}. \end{equation}
• Initial condition: \begin{equation} v(S,0) = \max\{K-S,0\}. \end{equation}
• Parameters: \begin{equation} T = 0.25, \, K = 100, \, r = 0.05, \, \sigma = 0.15, \, \lambda = 0.1, \, \delta = 0.45, \, m = -0.9. \end{equation}

Quick Start

• Compiling and running:

  cd ./Ruby
  make library
  ifort tst_Ruby.f90 -llibrary -llapack -lblas
  ./a.out
  matlab plot_Ruby.m
  

• Graphics: The exact solution (blue lines) and the numerical solution (red dots) of the put option, its gamma, and its delta are shown against the stock price.

References

• Feng Chen, Jie Shen, and Haijun Yu. A new spectral element method for pricing European options under the Black-Scholes and Merton jump diffusion models, Journal of Scientific Computing, Volume 52, Number 3, 499-518, (2012).

Code Highlights

!>
!! Exact evaluation of a Merton put option;
!! For comparing the numerical solution.
!< 
function Merton_put(m, tau, s, K, r, &
 sigma, lambda, delta, mean) result(y)
    
    ! number of evaluations
    integer, intent(in) :: m
    ! terminal time
    real(kind=8), intent(in) :: tau
    ! strike price
    real(kind=8), intent(in) :: K
    ! interest rate
    real(kind=8), intent(in) :: r
    ! dividend
    real(kind=8), intent(in) :: sigma
    ! jump intensity
    real(kind=8), intent(in) :: lambda
    ! jump variance
    real(kind=8), intent(in) :: delta
    ! jump mean
    real(kind=8), intent(in) :: mean
    ! stock prices
    real(kind=8), intent(in), dimension(m) :: s
    ! option prices
    real(kind=8), dimension(m) :: y 
    
    ! shifted mean
    real(kind=8) ::  kappa
    ! log kappa
    real(kind=8) :: vgamma
    ! shifted rate
    real(kind=8) :: rm
    ! each BS option in the summatino
    real(kind=8) :: each
    ! shifted jump intensity
    real(kind=8) :: lambdap
    ! shifted jump variance
    real(kind=8) :: sigmam
    
    ! temporary variables
    real(kind=8) :: temp, temp2
    integer :: i, n
        
    kappa = exp(mean+delta*delta/2d0)-1d0
    vgamma = log(1d0+kappa)
    rm = 0d0
    each = 0d0
    n = 0
    sigmam = 0d0
    lambdap = lambda * (1d0 + kappa)
    temp = 0d0
    temp2 = 0d0
    y = 0d0
    do i = 1, m  ! evaluate each option
        do n = 0, 30 ! cut the series to item 30
            rm = r - lambda*kappa + n*vgamma/tau
            sigmam = sqrt(sigma*sigma + n*delta*delta/tau)
            temp = -lambdap*tau + n*log(lambdap*tau) - sum_log(n)
            each = exp(temp)
            ! evaluation based on the BS option
            each = each * BS_put_generic(tau, s(i), K, rm, sigmam)
            ! accumulated sum
            y(i) = y(i) + each
        end do
    end do   
end function Merton_put