Project CEMAPRE internal
|Title||Lévy processes and fractional differential equations: Financial models and Option pricing|
|Participants||Nicola Cantarutti, Manuel Guerra, João Guerra (Principal Investigator)|
|Summary||Partial integro-differential equations (PIDE's) and fractional partial differential equations|
(FPDE's) appear in option pricing models with jumps (modeled by Lévy processes). These equations
generalize the Black-Scholes PDE when the continuous diffusion dynamics for the underlying price is
replaced by a Lévy process dynamics (including jumps).
For certain Lévy processes (as the CGMY), the pricing PIDE can be transformed in a Fractional
partial differential equation involving fractional derivatives.
The fractional Brownian motion (fBm) has been extensively studied as it finds applications in many
different situations, e.g., modelling turbulence or the log returns of a stock. The fBm is a
one-parameter family of Gaussian processes derived from the Brownian motion. The main feature of the
fBm is that the increments are no longer independent, so the process has long-range memory. Some
applications to finance can be formulated in terms of Stochastic Differential Equations with respect
to fBm. These kind of equations also involve fractional derivatives and fractional calculus.
Therefore, the techniques used in the study of fractional partial differential equations are also
useful in the study of SDE's driven by fBm.
In this project we will study some particular problems related to Lévy processes, fractional
calculus, fractional partial differential equations, fractional Brownian motion and applications in
I) The optimization problem related to the option pricing problem in a exponential Lévy model
market with transaction costs (In collaboration with Nicola Cantarutti and Manuel Guerra)
II) The option pricing FPDE and numerical methods for this FPDE for market models where the driving
process is the CGMY Lévy process and similar processes