Fast Laplace Transform Methods for Free-Boundary Problems of Fractional Diffusion Equations

Abstract

In this paper we develop a fast Laplace transform method for solving a class of free-boundary fractional diffusion equations arising in the American option pricing. Instead of using the time-stepping methods, we develop the Laplace transform methods for solving the free-boundary fractional diffusion equations. By approximating the free boundary, the Laplace transform is taken on a fixed space region to replace discretizing the temporal variable. The hyperbola contour integral method is exploited to restore the option values. Meanwhile, the coefficient matrix has theoretically proven to be sectorial. Therefore, the highly accurate approximation by the fast Laplace transform method is guaranteed. The numerical results confirm that the proposed method outperforms the full finite difference methods in regard to the accuracy and complexity.