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An Introduction To The Finite Difference Method PDF
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An Introduction To The Finite Difference Method PDF
An Introduction To The Finite Difference Method PDF
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Karam JaradatCopyright:
Available Formats
a.bergara@ehu.es
•
•
•
= =
+ ∆ = + ∆
∆
= ∆
∆
=
α
= =
+ ∆
+ ∆ −
=
= ∆→ ∆
=
7 x4
2
- 1+ x - x +
3
12
= +
− + Ο − +
=
=
-
- -
= − − −
7x4 x5 31x6 x7 127x8
- 2 3
- 1+ x - x + - + - +
- - 12 4 360 40 20160
2 3
- 1 + x
2
- 1+ x - x
-
-
- -
−
- -
-
−
−
- -
′ = − +
=
clear;
% Coefficients of the equation: a x'=b x + c t
a=1.;
b=-2.;
c=1.;
% Initial and final times
tinit= 0.;
tmax=5.;
% Number of time steps
maxt = 3000;
dt = (tmax-tinit)/maxt;
% Initial condition
x(1)=1.;
t(1)=tinit;
+ ∆ ≈ + ∆ = + ∆
% Time loop
for j=1:maxt;
x(j+1)=x(j)+dt*((b*x(j)+c*(j)*dt)/a);
t(j+1)=tinit+j*dt;
end;
% Figure
plot(t,x)
+ = + ∆ + Ο ∆ = + ∆
title('Euler Method')
xlabel('T')
ylabel('X(t)')
% Matlab Program 2: Solving the a x'=b x + c t ODE by using the
midpoint method
clear;
% Coefficients of equation a x'=b x + c t
+ = + + + ∆ + Ο ∆ a=1.;
b=-2.;
c=1.;
% Initial and Final Times
tinit= 0.;
tmax=5.;
% Number of Time Steps
maxt = 3000;
dt = (tmax-tinit)/maxt;
% Initial Condition
x(2)=1.;
x(1)=1.0-dt*((b*x(2)+c*(2)*dt)/a);
t(2)=tinit;
∆
% Time Loop
for j=2:(maxt+1);
x(j+1)=x(j-1)+2.*dt*((b*x(j)+c*(j)*dt)/a);
t(j+1)=tinit+(j-1)*dt;
end;
plot(t,x)
+ = − + ∆ + Ο ∆ title('Midpoint Method')
xlabel('T')
ylabel('X(t)')
− = − ∆
= ∆
∆
= ∆ + +
∆
= ∆ + +
= ∆ + ∆ +
∆ ∆
+ = + + + ∆ + = + + + + + Ο ∆
•
•
= ∆ •
∆
= ∆ + +
+ = + + Ο ∆
′′ + ′ + = = ′ = ′ ′′ + ′ + =
= ′ =
′ =
′ = − −
= = ′
′′ + ′ + =
+ + =
• ≠ = + +
• = = ∈ ℜ = + +
∂ ∂
− =
∂ ∂
= =
π
=
−
=
π
±
−
• =
π
∂ ∂ ∂ ∂ ∂
+ + =
∂
∂∂ ∂
∂ ∂
1
∂ ∂
0.75 10
∂ ∂
0.5
0.25 8
0 6
-4
• − > → -2
4
0
2
2
4
0
∂
∂
=
∂
∂ − ∞
−
−
• =
−∞ π π
• − = →
∂ ∂
=
∂ ∂
1
0.75
• − < →
0.5
20
0.25
0
15
10
∂ ∂
-4
+ = -2
0 5
∂ ∂ 2
4
0
= =
∂
+ = ∀ ∈ ∂ Ω ∀
∂
λτ λ τ
τ
λ
α β
= τ τ
τ
• >
∂ ∂
= τ >
∂τ ∂
•
• =
τ = → ∞τ →
τ ξ = τ
τ = ξ
+ ξ = ∂ ∂
ξ ξ = τ >
∂τ ∂
= ∞ =
= δ
→ ±∞τ →
ξ
ξ = −
+ τ
ξ = τ
δ τ = τ − δ ξ
∞
δ ξ δ
ξ =
−
+ =
π ξ
ξ ξ
∞
τ
−
τ
∞
−∞
τ =
−
τ
π τ
δ ξ = −ξ
+
∞
= π δ τ =
−∞
− τ
δ τ = = + ∆ =
πτ
= + ∆ =
≡
− ∞ < < ∞ τ >
=
∞
= ξ δ − ξ ξ
−∞
− −
δ − τ = τ
πτ
δ −
∞
τ
τ =
− −
πτ −∞ ∆
∆
∂ ∂
=
∂ ∂ + − + − −
= −
∆ ∆
∆
+ = − (
+ − − )
∆
∂ + − ∂ + − −
= + Ο∆ = + Ο∆
∂ ∆ ∂ ∆
+
+
+
% Matlab Program 3: Square-wave Test for the Explicit Method to solve
% the Advection Equation
clear;
% Parameters to define the advection equation and the range in space and
% time
Lmax = 1.0; % Maximum length
Tmax = 1.; % Maximum time
c = 1.0; % Advection velocity
% Parameters needed to solve the equation within the explicit method
maxt = 3000; % Number of time steps
dt = Tmax/maxt;
n = 30; % Number of space steps
nint=15; % The wave-front: intermediate point from which u=0
dx = Lmax/n;
b = c*dt/(2.*dx);
% Initial value of the function u (amplitude of the wave)
for i = 1:(n+1)
if i < nint
u(i,1)=1.;
else
u(i,1)=0.;
end
x(i) =(i-1)*dx;
end
% Value of the amplitude at the boundary
for k=1:maxt+1
u(1,k) = 1.;
u(n+1,k) = 0.;
time(k) = (k-1)*dt;
end
% Implementation of the explicit method
for k=1:maxt % Time loop
for i=2:n % Space loop
u(i,k+1) =u(i,k)-b*(u(i+1,k)-u(i-1,k));
end
end
% Graphical representation of the wave at different selected times
plot(x,u(:,1),'-',x,u(:,10),'-',x,u(:,50),'-',x,u(:,100),'-')
title('Square-wave test within the Explicit Method I')
xlabel('X')
ylabel('Amplitude(X)')
= ∆
→ ( + + − )
ξ = ξ ∆
ξ >
∆
ξ = −
∆
∆ ξ > + =
(+ + − ) − ∆ (+ − − )
∆
∆ ∆
∂
= ∆
∂ ξ = ∆ − ∆
∆
ξ <
=
∆
=
− ≤
∆
−
=
= λ = λ ∆
% Matlab Program 4: Step-wave Test for the Lax method to solve the Advection
% Equation
clear;
% Parameters to define the advection equation and the range in space and time ∆
Lmax = 1.0; % Maximum length =
Tmax = 1.; % Maximum time ∆
c = 1.0; % Advection velocity
% Parameters needed to solve the equation within the Lax method
maxt = 350; % Number of time steps
dt = Tmax/maxt;
n = 300; % Number of space steps
nint=50; % The wave-front: intermediate point from which u=0
(nint<n)!!
dx = Lmax/n;
b = c*dt/(2.*dx);
% The Lax method is stable for abs(b)=< 1/2 but it gets difussed unless abs(b)=
% 1/2
% Initial value of the function u (amplitude of the wave)
for i = 1:(n+1)
if i < nint
u(i,1)=1.;
else ∆
u(i,1)=0.; =
end ∆
x(i) =(i-1)*dx;
end
% Value of the amplitude at the boundary at any time
for k=1:maxt+1
u(1,k) = 1.;
u(n+1,k) = 0.;
time(k) = (k-1)*dt;
end
% Implementation of the Lax method
for k=1:maxt % Time loop
for i=2:n % Space loop
u(i,k+1) =0.5*(u(i+1,k)+u(i-1,k))-b*(u(i+1,k)-u(i-1,k)); ∆
end =
end ∆
% Graphical representations of the evolution of the wave
figure(1)
mesh(x,time,u')
title('Square-wave test within the Lax Method')
xlabel('X')
ylabel('T')
figure(2)
plot(x,u(:,1),'-',x,u(:,20),'-',x,u(:,50),'-',x,u(:,100),'-')
title('Square-wave test within the Lax Method')
xlabel('X')
ylabel('Amplitude(X)')
∆
• > →
∆
∆
• < →
∆
+ − − + − −
∆
=
• = → ∆ ∆
∆
ξ
∆
ξ − = ξ ∆
∆
∂ ∂ ∆ ∂
= + ∆ ∆
∂ ∂ ∆ ∂ ξ = ∆ ± − ∆
∆ ∆
ξ = ∆ ≤ ∆
∂ ∂ ∂
=
∂ ∂ ∂
∂ ∂
=
∂ ∂
∂ + − ∂ + − + −
= + Ο ∆ = + Ο ∆
∂ ∆ ∂ ∆
% Matlab Program 5: Heat Diffusion in one dimensional wire within the
% Explicit Method
clear;
% Parameters to define the heat equation and the range in space and time
L = 1.;
T =1.;
% Length of the wire
% Final time
+ − + − + −
= % Parameters needed to solve the equation within the explicit method
∆ ∆ maxk = 2500; % Number of time steps
dt = T/maxk;
n = 50; % Number of space steps
dx = L/n;
cond = 1/4; % Conductivity
+ = α + + − α + α − b = 2.*cond*dt/(dx*dx); % Stability parameter (b=<1)
% Initial temperature of the wire: a sinus.
for i = 1:n+1
∆
α = x(i) =(i-1)*dx;
∆ end
u(i,1) =sin(pi*x(i));
% Temperature at the boundary (T=0)
for k=1:maxk+1
u(1,k) = 0.;
u(n+1,k) = 0.;
time(k) = (k-1)*dt;
end
% Implementation of the explicit method
for k=1:maxk % Time Loop
for i=2:n; % Space Loop
u(i,k+1) =u(i,k) + 0.5*b*(u(i-1,k)+u(i+1,k)-2.*u(i,k));
end
end
% Graphical representation of the temperature at different selected times
figure(1)
plot(x,u(:,1),'-',x,u(:,100),'-',x,u(:,300),'-',x,u(:,600),'-')
title('Temperature within the explicit method')
xlabel('X')
ylabel('T')
figure(2)
mesh(x,time,u')
title('Temperature within the explicit method')
xlabel('X')
ylabel('Temperature')
∆
=
∆
= ξ ∆
∆ ∆
ξ = − ξ ≤
(∆ )
∆
∆
= ∆
≤
∆ ∆
∆ << ∆ <<
+
= −α − + + + α + − α + +
∆
= − α =
+ − + + − + + − + ∆
=
∆ ∆
ξ =
∆
+ α
ξ ≤ ∆
∆
∆ → ∞
% Matlab Program 6: Heat Diffusion in one dimensional wire within the Fully
% Implicit Method
clear;
% Parameters to define the heat equation and the range in space and time
L = 1.; % Lenth of the wire
T =1.; % Final time
% Parameters needed to solve the equation within the fully implicit method
maxk = 2500; % Number of time steps
dt = T/maxk;
n = 50.; % Number of space steps
∆
dx = L/n; =
cond = 1./4.; % Conductivity ∆
b = cond*dt/(dx*dx); % Parameter of the method
% Initial temperature of the wire: a sinus.
for i = 1:n+1
x(i) =(i-1)*dx;
u(i,1) =sin(pi*x(i));
end
% Temperature at the boundary (T=0)
for k=1:maxk+1
u(1,k) = 0.;
u(n+1,k) = 0.;
time(k) = (k-1)*dt;
end
aa(1:n-2)=-b;
bb(1:n-1)=1.+2.*b;
cc(1:n-2)=-b;
MM=inv(diag(bb,0)+diag(aa,-1)+diag(cc,1));
∆
% Implementation of the implicit method =
for k=2:maxk
uu=u(2:n,k-1);
% Time Loop ∆
u(2:n,k)=MM*uu;
end
% Graphical representation of the temperature at different selected times
figure(1)
plot(x,u(:,1),'-',x,u(:,100),'-',x,u(:,300),'-',x,u(:,600),'-')
title('Temperature within the fully implicit method')
xlabel('X')
ylabel('T')
figure(2)
mesh(x,time,u')
title('Temperature within the fully implicit method')
xlabel('X')
ylabel('Temperature')
∆
− α
− + + − + + − + + + − + − ξ =
+ = ∆
∆ ∆ + α
ξ ≤ ∆
α − + − α + α + = −α − + + + α + − α + +
≤ ≤ −
+ + +
+ =
+
+ +
− α + α −α +
− α + α − α
=
+ α − α
+ +
+ α − α − +
−α
+
+
α − α α
− α + α − α
+
α − α α
−α + α −α
− α α
+ α − α
− α α −
α
−α + α −α − +
+
% Matlab Program 7: Heat Diffusion in one dimensional wire within the
% Crank-Nicholson Method
clear;
+ − α +
% Parameters to define the heat equation and the range in space and time
L = 1.; % Lenth of the wire
+ α −α T =1.; % Final time
−α + α
% Parameters needed to solve the equation within the Crank-Nicholson method
maxk = 2500; % Number of time steps
dt = T/maxk;
−α + n = 50.; % Number of space steps
dx = L/n;
cond = 1/2; % Conductivity
− α + α − α b = cond*dt/(dx*dx); % Parameter of the method
− α + α % Initial temperature of the wire: a sinus.
− α for i = 1:n+1
− + +
x(i) =(i-1)*dx;
u(i,1) =sin(pi*x(i));
end
=+ + + +
% Temperature at the boundary (T=0)
for k=1:maxk+1
u(1,k) = 0.;
u(n+1,k) = 0.;
end
time(k) = (k-1)*dt;
% Defining the Matrices M_right and M_left in the method
aal(1:n-2)=-b;
bbl(1:n-1)=2.+2.*b;
ccl(1:n-2)=-b;
+ + = − + + MMl=diag(bbl,0)+diag(aal,-1)+diag(ccl,1);
aar(1:n-2)=b;
bbr(1:n-1)=2.-2.*b;
ccr(1:n-2)=b;
MMr=diag(bbr,0)+diag(aar,-1)+diag(ccr,1);
+ +
% Implementation of the Crank-Nicholson method
for k=2:maxk % Time Loop
uu=u(2:n,k-1);
u(2:n,k)=inv(MMl)*MMr*uu;
end
+ = Μ + − − + +
% Graphical representation of the temperature at different selected times
figure(1)
plot(x,u(:,1),'-',x,u(:,100),'-',x,u(:,300),'-',x,u(:,600),'-')
title('Temperature within the Crank-Nicholson method')
xlabel('X')
ylabel('T')
figure(2)
mesh(x,time,u')
title('Temperature within the Crank-Nicholson method')
xlabel('X')
ylabel('Temperature')
[L,U]=lu(M))
+
∆
=
∆
=
+ α − α
− α + α
−α =
− α + α − α
− α + α
∆
=
∆
−
− − −
−
−
% Matlab Program 8: Heat Diffusion in one dimensional wire within the
% Crank-Nicholson Method
% by using the LU decomposition.
clear;
% Parameters to define the heat equation and the range in space and time
L = 1.; % Lenth of the wire
= + α T = 1.; % Final time
% Parameters needed to solve the equation within the Crank-Nicholson method
% by using the LU decomposition
− = − = −α = + α − − ≤ ≤ − maxk = 2500; % Number of time steps
dt = T/maxk;
n = 50.; % Number of space steps
dx = L/n;
cond = 1./4.; % Conductivity
b = cond*dt/(dx*dx); % Parameter of the method
% Initial temperature of the wire: a sinus.
for i = 1:n+1
x(i) =(i-1)*dx;
v(i,1) =sin(pi*x(i));
end
% Temperature at the boundary (T=0)
for k=1:maxk+1
v(1,k) = 0.;
+ + = − + + v(n+1,k) = 0.;
end
time(k) = (k-1)*dt;
% Defining the Matrices M_right and M_left in the method
aal(1:n-2)=-b;
bbl(1:n-1)=2.+2.*b;
= = = = ccl(1:n-2)=-b;
MMl=diag(bbl,0)+diag(aal,-1)+diag(ccl,1);
[L,U]=lu(MMl); % LU decomposition
aar(1:n-2)=b;
bbr(1:n-1)=2.-2.*b;
ccr(1:n-2)=b;
MMr=diag(bbr,0)+diag(aar,-1)+diag(ccr,1);
% Implementation of the LU decomposition within the Crank-Nicholson method
for k=2:maxk % Time Loop
vv=v(2:n,k-1);
• = = − − qq=MMr*vv;
w(1)=qq(1);
≤ ≤ − for j=2:n-1
w(j)=qq(j)-L(j,j-1)*w(j-1);
end
v(n,k)=w(n-1)/U(n-1,n-1);
• for i=n-1:-1:2
v(i,k)=(w(i-1)-U(i-1,i)*v(i+1,k))/U(i-1,i-1);
− − + end
− = = − ≥ ≥ end
− % Graphical representation of the temperature at different selected times
figure(1)
plot(x,v(:,1),'-',x,v(:,100),'-',x,v(:,300),'-',x,v(:,600),'-')
title('Temperature within the Crank-Nicholson method (LU)')
xlabel('X')
ylabel('T')
figure(2)
mesh(x,time,v')
title('Temperature within the Crank-Nicholson method (LU)')
xlabel('X')
ylabel('Temperature')
+ = [
− + + ]
=
+ = [
− + + ]
+ = [
− + + ]
+ + + =
+ + + =
+ + + =
= + +
[
+ = − − + ]
= − + +
+
= − + +
= − + +
−
+ =
− +
−
= =
+ −
ω −
+ = − ω +
− +
−
= =
[( )
+ = + ω − − − ω − ω − + ω − ]
ω
= −
[(
+ = + ω − − − ω − ω − )]
ω
ω
σ µ ≡
∂ ∂ ∂
Π = + σ
+ − ∆
∂ ∂
∂
Π
∆
∂
∆ =
Π = − ∆ ∂
= µ + σ
Π = − ∆
∆
∂ ∂ ∂ ∂ ∂
= + σ
+ Π = + σ
∂ ∂
∂ ∂ ∂
∂ ∂ ∂
Π = + σ
+ − ∆
∂ ∂ ∂ Π = Π
σ
σ
∂ ∂ ∂
+ σ + − =
∂ ∂
∂
σ
•
•
= → ∞ =
•
=
•
•
•
• = Θ −
• = −
• = − • = Θ −
•
• = − − −
•
• = − − −
•
= α+ βτ τ
α = − − β = − + = = − τ
• σ σ σ
τ
∂ ∂
=
∂ ∂
= ξ + − σ τ
= τ
∂ ∂ ∂
+ σ + − = ∂ ∂
∂ ∂
∂ = σ
∂τ ∂
− ′
−
τ = σ τ
′
= − − πτ σ
∂ ∂ ∂
+ σ + =
∂ ∂
∂ τ →
δ − ′
τ = −
− ′
∞ −
∂ ∂ ∂ σ τ
′ ′ =
= σ + τ → πτ σ −∞
∂τ ∂
∂
=
ξ =
=
∂ ∂ ∂
= σ + − σ
∂τ ∂ξ ∂ξ
τ >
∞ − ′
− ∂
τ = ′ ′ • ∆ =
σ τ
πτ σ −∞
∂
∆
∆
∂
• Γ = Γ ∆
′ + − σ − ∂
− − ∞ −
σ − ′
′
π − σ
=
′
Γ
∂
• Θ =
∂
∆
• = − − −
∂
• =
∂σ
+ + σ − + − σ −
= =
σ − σ −
−
=
π
−∞
∂
• ρ =
∂
• = − − + − − −
∂ ∂ ∂
+ σ + [ − ] − =
∂ ∂ ∂
∂ ∂ ∂
+ σ + − − =
∂ ∂
∂
α = α
∂ ∂ ∂
+ α σ + α σ α − + − =
∂ ∂ ∂ ∂ ∂
∂
+ σ + − − =
∂ ∂
∂
= +
∂ ∂ ∂ ∂ ∂
∂ ∂ ∂ + σ + + + − λ − =
+ σ + + − = ∂ ∂
∂
∂ ∂
∂ ∂
∂
= −
=
∂ ∂
+ σ − =
∂ ∂
≤ < ∞ ∆
∞
= ∆ = ∂ ∂ ∂
+ σ + − =
= − ∆ = ∂ ∂
∂
≡
∂ ∂ ∂
+ + + =
∂ ∂ ∂
+ −
∆
+ − + −
+
∆
+ − −
+
∆
∆
+ = Ο ∆ ∆
∆
= ∆
= − − +
− +
+ = ν − ν −
+ − ν + ∆
+ν + ν +
= ∀
+Ο
− − −
∆ ∆
ν = ν = = ∆ − − ∆
∆
∆
+ = σ ∆ − = − − = − ∆
[
+ − σ + ∆ ]
+ σ + ∆ + =
+Ο
∂ −
− = = + + −
∂ =
Ο∆ ∆∆
= − ∆ −
Ο ∆ ∆∆
= Ο∆ −
Ο∆ ∆
∂
→ → ∞ = ξ ∆
∂
= − − − [
ξ = + ∆ + ν ( ∆ − )] +
ν ∆
ξ <
∆
≤
ν − ∆ ≤
∂ −
( )
ν ≤ ν
≥
∂
= + +
∆
•
∂ − −
≤ = −
∂ ∆
• ν
ν <
Ο∆ Ο∆
∆
∆ ≤ = •
σ
∂ = − + + ∆ − + ∆ + Ο ∆
• ∂ ∆
σ •
∆ ≤ =
( )
∂ − − ∆ + − ∆
= + Ο ∆
∂ ∆
% Matlab Program 9: Evaluates an European Call option by using an explicit
method
% Parameters of the problem:
%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
σ
r=0.2; % Interest rate
sigma=0.25; % Volatility of the underlying
M=1600; % Number of time points
N=160; % Number of share price points
Smax=20; % Maximum share price considered
Smin=0; % Minimum share price considered
T=1.; % Maturation (expiry)of contract
E=10; % Exercise price of the underlying
%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
dt=(T/M); % Time step
ds=(Smax-Smin)/N; % Price step
% Initializing the matrix of the option value
v(1:N,1:M) = 0.0;
% Initial conditions prescribed by the European Call payoff at expiry:
V(S,T)=max(S-E,0)
v(1:N,1)=max((Smin+(0:N-1)*ds-E),zeros(size(1:N)))';
% Boundary conditions prescribed by the European Call:
v(1,2:M)=zeros(M-1,1)'; % V(0,t)=0
v(N,2:M)=((N-1)*ds+Smin)-E*exp(-r*(1:M-1)*dt); % V(S,t)=S-Eexp[-r(T-t)] as S ->
infininty.
% Determining the matrix coeficients of the explicit algorithm
aa=0.5*dt*(sigma*sigma*(1:N-2).*(1:N-2)-r*(1:N-2))';
bb=1-dt*(sigma*sigma*(1:N-2).*(1:N-2)+r)';
cc=0.5*dt*(sigma*sigma*(1:N-2).*(1:N-2)+r*(1:N-2))';
% Implementing the explicit algorithm
for i=2:M,
v(2:N-1,i)=bb.*v(2:N-1,i-1)+cc.*v(3:N,i-1)+aa.*v(1:N-2,i-1);
end
% Reversal of the time components in the matrix as the solution of the Black-
Scholes
% equation was performed backwards
v=fliplr(v);
% Figure of the value of the option, V(S,t), as a function of S
% at three different times:t=0, T/2 and T (expiry).
figure(1)
plot(Smin+ds*(0:N-1),v(1:N,1)','r-',Smin+ds*(0:N-1),v(1:N,round(M/2))','g-
',Smin+ds*(0:N-1),v(1:N,M)','b-');
xlabel('S');
ylabel('V(S,t)');
title('European Call Option within the Explicit Method');
% Figure of the Value of the option, V(S,t)
figure(2)
mesh(Smin+ds*(0:N-1),dt*(0:M-1),v(1:N,1:M)')
title('European Call Option value, V(S,t), within the Explicit Method')
xlabel('S')
ylabel('t')
= −ν + − ν + − +
+ + ν + − ∆ + +
+ −ν + + ν + + +
+Ο
∆ ∆
+ − ν = ν =
∆
∆
∆
+ + − + + − + = − − +
+
+
∆ − +
+ + − − +
+ +
∆
+ + + = Ο ∆ ∆
+ − + + + + + + + + + =
− − + − − +
+ −
∆
+ + + − + + − +
+
∆
= ν + ν
+ − + −
+ = −ν + ∆
∆
+ + + − − +
+ = ν − ν
∆
+ − −
+
∆ ≤ ≤ −
+ + + + = Ο ∆ ∆
+
+ + + + + + +
+ + + +
=
+ − + − + = = − − −
+
− + − + − + − + + = + = ∆ − − + ∆
+
+
− − − + + + + +
− − − + + + +
− − − − + − + − +
− − − − − − − − + + − + − + − +
+
+ + +
+ + +
+ + +
+
+ − + − +
+
− + − +
+ + + + = +
− + − + +
=
+ + + +
+
∂
=
∂ + = Μ + − − + +
+ = + − + + = − + − − +
+
+
+ + + + + − +
=
+ + +
+
+− + − +
+
− + −− + +− + +− + =
−
− +
− + − −
− + −
−
+ + = − + +
− − −
= − −
= +
− = − = − = + − − ≤ ≤ −
+ =
[
− + + ]
+ =
[
− + + ]
+ + = − + +
+ =
[
− + + ]
= = = =
• = = − −
≤ ≤ −
= + +
•
− =
−
−
=
− +
− ≥ ≥ [
+ = − − + ]
−
+
=
−
+
−
= =
+ −
ω −
+ = − ω +
−
+
−
= =
+
[( )
= + ω − − − ω − ω − + ω − ]
Ο∆ ∆
• ∆ ∆
•
•
∂ ∂
=
∂ ∂
•
+ − + − + −
=
∆ ∆
+ − + + − + + − +
=
∆ ∆
θ
+ − + − + − + + − + + − +
∆ = − θ +θ
∆
∆
+ − − + − + −
=
∆ ∆
θ =
θ
+ − − + − + − − + −
=
∆ ∆
Ο ∆ − ∆ − θ∆ ∆ ∆
+ ν + = ν + + − + − ν −
θ =
∆
θ= −
∆
∆
∆ ∆
∆
=+ ε ∆ + ε ∆ + ε ∆ + =
Ο∆ ∆
∆
= + ε +ε
+
∆
=+ ε ∆ + ε ∆ + ε ∆ +
∆ ∆
=
∆ ∆
( )
( )
=+ ε ∆ + ε ∆ + ε ∆ + =
∆
= + ε +ε +
∆ ∆ − ∆
=
∆ − ∆
+
≥
∆
+ ω −
= − ω +
−
+
−
= =
( )
+ = − + + + +
% Matlab Program 10: Compares European and American Call options by using an
% explicit method Parameters of the problem:
%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
r=0.2; % Interest rate
sigma=0.25; % Volatility of the underlying
d=0.3; % Continuous dividend yield
M=1600; % Number of time points
N=160; % Number of share price points
Smax=20; % Maximum share price considered σ
Smin=0; % Minimum share price considered
T=1.; % Maturation (expiry)of contract
E=10; % Exercise price of the underlying
%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
dt=(T/M); % Time step
ds=(Smax-Smin)/N; % Price step
% Initializing the matrix of the option values: v is the European and vam is the
American option
v(1:N,1:M) = 0.0;
vam(1:N,1:M) = 0.0;
% Initial conditions prescribed by the Call payoff at expiry: V(S,T)=max(E-S,0)
v(1:N,1)=max((Smin+(0:N-1)*ds-E),zeros(size(1:N)))';
vam(1:N,1)=max((Smin+(0:N-1)*ds-E),zeros(size(1:N)))';
% Boundary conditions prescribed by Call Options with dividends:
% V(0,t)=0
v(1,2:M)=zeros(M-1,1)';
vam(1,2:M)=zeros(M-1,1)';
% V(S,t)=Se^(-d*(T-t))-Ee^(-r(T-t)) as S -> infininty.
v(N,2:M)=((N-1)*ds+Smin)*exp(-d*(1:M-1)*dt)-E*exp(-r*(1:M-1)*dt);
vam(N,2:M)=((N-1)*ds+Smin)*exp(-d*(1:M-1)*dt)-E*exp(-r*(1:M-1)*dt);
% Determining the matrix coeficients of the explicit algorithm
aa=0.5*dt*(sigma*sigma*(1:N-2).*(1:N-2)-(r-d)*(1:N-2))';
bb=1-dt*(sigma*sigma*(1:N-2).*(1:N-2)+r)';
cc=0.5*dt*(sigma*sigma*(1:N-2).*(1:N-2)+(r-d)*(1:N-2))';
% Implementing the explicit algorithm
for i=2:M,
v(2:N-1,i)=bb.*v(2:N-1,i-1)+cc.*v(3:N,i-1)+aa.*v(1:N-2,i-1);
% Checks if early exercise is better for the American Option
vam(2:N-1,i)=max(bb.*vam(2:N-1,i-1)+cc.*vam(3:N,i-1)+aa.*vam(1:N-2,i-
1),vam(2:N-1,1));
end
% Reversal of the time components in the matrix as the solution of the Black-
Scholes
% equation was performed backwards
v=fliplr(v);
vam=fliplr(vam);
% Compares the value today of the European (blue) and American (red) Calls,
V(S,t), as a function of S.
% The green curve represents the payoff at expiry.
plot(Smin+ds*(0:(N-2)),v(1:(N-1),M)','g-',Smin+ds*(0:(N-2)),v(1:(N-1),1)','b-
',Smin+ds*(0:(N-2)),vam(1:(N-1),1)','r-');
xlabel('S');
ylabel('V(S,t)');
title('European (blue) and American (red) Call Options');
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