Computational Economics

, Volume 53, Issue 1, pp 191–205

A Stable and Convergent Finite Difference Method for Fractional Black–Scholes Model of American Put Option Pricing

• R. Kalantari
Article

Abstract

We introduce the mathematical modeling of American put option under the fractional Black–Scholes model, which leads to a free boundary problem. Then the free boundary (optimal exercise boundary) that is unknown, is found by the quasi-stationary method that cause American put option problem to be solvable. In continuation we use a finite difference method for derivatives with respect to stock price, Grünwal Letnikov approximation for derivatives with respect to time and reach a fractional finite difference problem. We show that the set up fractional finite difference problem is stable and convergent. We also show that the numerical results satisfy the physical conditions of American put option pricing under the FBS model.

Keywords

Fractional differential equation American option pricing Quasi-stationary Finite difference method Newton interpolation method

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