Applying the Model Order Reduction method to a European option pricing model

Abstract

This paper presents a European option pricing model by applying the Model-Order-Reduction (MOR) method. A European option pricing theorem based on Black–Scholes' equation is implemented by the Finite-Difference Method (FDM). However, the numerical models generated by the FDM could be simplified through the MOR technique, which is based on the concept of an Arnoldi-based Model-Order Reduction algorithm. In terms of computational cost, the MOR models are at least 2 orders of magnitude faster than the original FDM models with a negligible compromise in accuracy.