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DOMAIN OF INFLUENCE OF LOCAL VOLATILITY FUNCTION ON THE SOLUTIONS OF THE GENERAL BLACK-SCHOLES EQUATION

  • Kim, Hyundong (Department of Mathematics, Korea University) ;
  • Kim, Sangkwon (Department of Mathematics, Korea University) ;
  • Han, Hyunsoo (Department of Financial Engineering, Korea University) ;
  • Jang, Hanbyeol (Department of Financial Engineering, Korea University) ;
  • Lee, Chaeyoung (Department of Mathematics, Korea University) ;
  • Kim, Junseok (Department of Mathematics, Korea University)
  • Received : 2019.04.12
  • Accepted : 2019.11.20
  • Published : 2020.02.29

Abstract

We investigate the domain of influence of the local volatility function on the solutions of the general Black-Scholes model. First, we generate the sample paths of underlying asset using the Monte Carlo simulation. Next, we define the inner and outer domains to find the effective volatility region. To confirm the effect of the inner domain, we use the root mean square error for the European call option prices, and then change the values of volatility in the proposed domain. The computational experiments confirm that there is an effective region which dominates the option pricing.

Keywords

References

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