A variable step‐size extrapolated Crank–Nicolson method for option pricing under stochastic volatility model with jump

Abstract

This paper studies the numerical solution of the stochastic volatility model with jumps under European options. This model can be transformed into a partial integro‐differential equation (PIDE) with spatial mixed derivative terms. Due to the nonsmoothness of the initial function, the variable step‐size extrapolated Crank–Nicolson (CN) method, which explicitly discretizes the jump term and implicitly the rest, is proposed to solve this model. The finite difference method is used to discretize the spatial differential operator, the composite trapezoidal rule to calculate the jump integral, and then a linear system with a nine‐diagonal coefficient matrix is obtained, which is easy to solve. The stability of the variable step‐size extrapolated CN method is then proved. Based on realistic regularity assumptions on the data, the consistency error and global error bounds of the variable step‐size extrapolated CN method are derived in norm. Compared with the variable step‐size IMEX BDF2 method and the variable step‐size IMEX MP method, the numerical results show the efficiency of the proposed variable step‐size extrapolated CN method.