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Pricing a class of exotic options via moments and SDP relaxations

Jean B. Lasserre (lasserre***at***laas.fr)
Thomas Prieto-Rumeau (tprieto***at***cee.uned.es)
Mihail Zervos (Mihail.Zervos***at***kcl.ac.uk)

Abstract: We present a new methodology for the numerical pricing of a class of exotic derivatives such as Asian or barrier options when the underlying asset price dynamics are modelled by a geometric Brownian motion or a number of mean-reverting processes of interest. This methodology identifies derivative prices with infinite-dimensional linear programming problems involving the moments of appropriate measures, and then develops suitable finite-dimensional relaxations that take the form of semi-definite programs indexed by the number of moments involved. By maximising or minimising appropriate criteria, monotone sequences of both upper and lower bounds are obtained. Numerical investigation shows that very good results are obtained with only a small number of moments. Theoretical convergence results are also established.

Keywords: Mathematical finance; option pricing; semidefinite relaxations

Category 1: Applications -- OR and Management Sciences (Finance and Economics )

Category 2: Applications -- Science and Engineering (Optimization of Systems modeled by PDEs )

Citation: Mathematical Finance 16, No 3 (2006), 469--494

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Entry Submitted: 09/23/2005
Entry Accepted: 09/23/2005
Entry Last Modified: 09/18/2006

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