Pricing derivative securities using integrated Quasi-Monte Carlo methods with dimension reduction and discontinuity realignment

Junichi Imai, Ken Seng Tan

Research output: Contribution to journalArticle

7 Citations (Scopus)

Abstract

The dimension and the smoothness of the integrands are the two key factors that affect the efficiency of the quasi-Monte Carlo (QMC) method. The first factor implies that the QMC method can have high performance on a problem with low effective dimension even though its nominal dimension can be very large. The second factor suggests that the QMC method can be very effective on a problem that is smooth or even on a problem that is discontinuous as long as its discontinuities are parallel to the axes. Motivated by these findings, methods such as the linear transformation (LT) method of [J. Imai and K. S. Tan, J. Comput. Finance, 10 (2006), pp. 129-155] and the orthogonal transformation (OT) method of [X. Wang and K. S. Tan, Management Sci., 59 (2013), pp. 376-389] have been proposed to increase the efficiency of QMC. However, both of these methods are unsatisfactory in that they only achieve optimality single sidedly in the sense that the LT method enhances QMC by effective dimension reduction while the OT method accomplishes the same objective by discontinuity realignment. On the other hand there are many problems in finance that are both of high dimensionality and discontinuous. The main objective of this paper is to propose an efficient QMC method for handling problems of this kind. We first prove that the OT method is a special case of the LT method. We then show that by integrating the LT and OT methods, the proposed method has the advantage of addressing both dimensionality and discontinuity concurrently. The numerical examples indicate that relative to the standard QMC, the proposed hybrid method is extremely effective and could attain a variance reduction as high as several thousand times. We further discuss a possible extension of the proposed method to the case under a Lévy process and demonstrate its competitive efficiency using some additional numerical examples.

Original languageEnglish
Pages (from-to)A2101-A2121
JournalSIAM Journal on Scientific Computing
Volume36
Issue number5
DOIs
Publication statusPublished - 2014

Fingerprint

Quasi-Monte Carlo Methods
Linear transformations
Dimension Reduction
Pricing
Discontinuity
Monte Carlo methods
Derivatives
Derivative
Finance
Orthogonal Transformation
Costs
Linear transformation
Quasi-Monte Carlo
Effective Dimension
Dimensionality
Numerical Examples
Variance Reduction
Integrand
Hybrid Method
Categorical or nominal

Keywords

  • Digital options
  • Dimension reduction
  • Linear transformation
  • Lévy process
  • Orthogonal transformation
  • Quasi-Monte Carlo method

ASJC Scopus subject areas

  • Applied Mathematics
  • Computational Mathematics

Cite this

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title = "Pricing derivative securities using integrated Quasi-Monte Carlo methods with dimension reduction and discontinuity realignment",
abstract = "The dimension and the smoothness of the integrands are the two key factors that affect the efficiency of the quasi-Monte Carlo (QMC) method. The first factor implies that the QMC method can have high performance on a problem with low effective dimension even though its nominal dimension can be very large. The second factor suggests that the QMC method can be very effective on a problem that is smooth or even on a problem that is discontinuous as long as its discontinuities are parallel to the axes. Motivated by these findings, methods such as the linear transformation (LT) method of [J. Imai and K. S. Tan, J. Comput. Finance, 10 (2006), pp. 129-155] and the orthogonal transformation (OT) method of [X. Wang and K. S. Tan, Management Sci., 59 (2013), pp. 376-389] have been proposed to increase the efficiency of QMC. However, both of these methods are unsatisfactory in that they only achieve optimality single sidedly in the sense that the LT method enhances QMC by effective dimension reduction while the OT method accomplishes the same objective by discontinuity realignment. On the other hand there are many problems in finance that are both of high dimensionality and discontinuous. The main objective of this paper is to propose an efficient QMC method for handling problems of this kind. We first prove that the OT method is a special case of the LT method. We then show that by integrating the LT and OT methods, the proposed method has the advantage of addressing both dimensionality and discontinuity concurrently. The numerical examples indicate that relative to the standard QMC, the proposed hybrid method is extremely effective and could attain a variance reduction as high as several thousand times. We further discuss a possible extension of the proposed method to the case under a L{\'e}vy process and demonstrate its competitive efficiency using some additional numerical examples.",
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T1 - Pricing derivative securities using integrated Quasi-Monte Carlo methods with dimension reduction and discontinuity realignment

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AB - The dimension and the smoothness of the integrands are the two key factors that affect the efficiency of the quasi-Monte Carlo (QMC) method. The first factor implies that the QMC method can have high performance on a problem with low effective dimension even though its nominal dimension can be very large. The second factor suggests that the QMC method can be very effective on a problem that is smooth or even on a problem that is discontinuous as long as its discontinuities are parallel to the axes. Motivated by these findings, methods such as the linear transformation (LT) method of [J. Imai and K. S. Tan, J. Comput. Finance, 10 (2006), pp. 129-155] and the orthogonal transformation (OT) method of [X. Wang and K. S. Tan, Management Sci., 59 (2013), pp. 376-389] have been proposed to increase the efficiency of QMC. However, both of these methods are unsatisfactory in that they only achieve optimality single sidedly in the sense that the LT method enhances QMC by effective dimension reduction while the OT method accomplishes the same objective by discontinuity realignment. On the other hand there are many problems in finance that are both of high dimensionality and discontinuous. The main objective of this paper is to propose an efficient QMC method for handling problems of this kind. We first prove that the OT method is a special case of the LT method. We then show that by integrating the LT and OT methods, the proposed method has the advantage of addressing both dimensionality and discontinuity concurrently. The numerical examples indicate that relative to the standard QMC, the proposed hybrid method is extremely effective and could attain a variance reduction as high as several thousand times. We further discuss a possible extension of the proposed method to the case under a Lévy process and demonstrate its competitive efficiency using some additional numerical examples.

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