DEPARTMENT OF MATHEMATICS

IIT GUWAHATI
MA 473 Computational Finance Lab – IV Date: 25.08.2023

1. Consider the following Black-Scholes PDE for European call:

2

 ∂V + 1 σ 2 (S)S 2 ∂ V + (r − δ)S ∂V − rV = 0,

0 ≤ S < ∞, t ≤ T,
∂t 2 ∂S 2 ∂S

V (S, t) = VT (S), 0 ≤ S < ∞.


With the following transformation


S
 ξ= , q > 0,


S+q


 τ = T − t,


V (S, T ) = (S + q) V (ξ, τ ),


the above European call option problem becomes the following parabolic PDE:
2

∂V 1 2 2 2 ∂ V ∂V
= σ (ξ)ξ (1 − ξ) + (r − δ)ξ(1 − ξ) − [r(1 − ξ) + δξ]V , 0 ≤ ξ ≤ 1, 0 ≤ τ ≤ T,


 ∂τ

 2 ∂ξ 2 ∂ξ

 V (ξ, 0) = max(2ξ − 1, 0), 0 ≤ ξ ≤ 1,


V (0, τ ) = V (0, 0)e−rτ , V (1, τ ) = V (1, 0)e−δτ , 0 ≤ τ ≤ T.


Solve the transformed PDE by the following schemes:

(i) Forward-Euler for time & central difference for space (FTCS) scheme.
(ii) Backward-Euler for time & central difference for space (BTCS) scheme.
(iii) Crank-Nicolson finite difference scheme.
S
The values of the parameters are T = 1, r = 0.04, σ(S) = , δ = 0.1.
4

Continued on the next page

1
 2. Consider the following European put option problem:
2

 ∂V + 1 σ 2 (S)S 2 ∂ V + (r − δ)S ∂V − rV = 0,

0 ≤ S < ∞, t ≤ T,
∂t 2 ∂S 2 ∂S

V (S, t) = VT (S), 0 ≤ S < ∞.


With the following transformation


S
 ξ = S + q , q > 0,




 τ = T − t,


V (S, T ) = (S + q) V (ξ, τ ),


the above European put option problem becomes the following parabolic PDE:
2

∂V 1 2 2 2 ∂ V ∂V
= σ (ξ)ξ (1 − ξ) + (r − δ)ξ(1 − ξ) − [r(1 − ξ) + δξ]V , 0 ≤ ξ ≤ 1, 0 ≤ τ ≤ T,


 ∂τ

 2 ∂ξ 2 ∂ξ

 V (ξ, 0) = max(1 − 2ξ, 0), 0 ≤ ξ ≤ 1,


V (0, τ ) = V (0, 0)e−rτ , V (1, τ ) = V (1, 0)e−δτ , 0 ≤ τ ≤ T.


Solve the transformed PDE by the following schemes:

(i) Forward-Euler for time & central difference for space (FTCS) scheme.
(ii) Backward-Euler for time & central difference for space (BTCS) scheme.
(iii) Crank-Nicolson finite difference scheme.
S
The values of the parameters are T = 1, r = 0.04, σ(S) = , δ = 0.1.
4

 
qξ
Note : σ(ξ) = σ(S(ξ)) = σ .
1−ξ

The output files should contain the following for above problems:

a) Plot the numerical solutions at the final time level.

b) Draw the surface plot of the numerical solutions.