The evaluation of compound options based on RBF approximation methods

Abstract

Recently, real options have gained more importance in computational finance studies. It has already been shown that the compound option pricing can be formulated as a two-pass boundary PDE arising from Black–Scholes model. Radial basis function (RBF) as a meshfree approximation method is widely used for numerical study of the time dependent PDEs. In this paper, the aim is to introduce the robust numerical approach based on RBF-QR to compute the price of European compound options such as the popular put on put options. We also extend the proposed approach to American compound option pricing. The numerical experiments will show the efficiency of the performance for European and American compound option with single asset and multi-asset cases.