A Practical Monte Carlo Method for Pricing Equity-Linked Securities with Time-Dependent Volatility and Interest Rate

Sangkwon Kim, Jisang Lyu, Wonjin Lee, Eunchae Park, Hanbyeol Jang, Chaeyoung Lee, Junseok Kim

Research output: Contribution to journalArticlepeer-review

Abstract

We develop a fast Monte Carlo simulation (MCS) for pricing equity-linked securities (ELS) with time-dependent volatility and interest rate. In this paper, we extend a recently developed fast MCS for pricing ELS. In the previous model, both the volatility and interest rate were constant. However, in the real finance market, volatility and interest rate are time-dependent parameters. In this work, we approximate the time-dependent parameters by piecewise constant functions and apply Brownian bridge technique. We present some numerical results of the proposed method. The computational results demonstrate the fastness of the proposed algorithm with equivalent accuracy with standard MCS. It is important for traders and hedgers considering derivatives to evaluate prices and risks quickly and accurately. Therefore, our algorithm will be very useful to practitioners in the ELS market.

Original languageEnglish
JournalComputational Economics
DOIs
Publication statusAccepted/In press - 2023

Bibliographical note

Funding Information:
The corresponding author (J. S. Kim) was supported by the BK21 Plus program from the Ministry of Education of Korea. The authors appreciate the reviewers for their constructive comments on this article.

Publisher Copyright:
© 2023, The Author(s), under exclusive licence to Springer Science+Business Media, LLC, part of Springer Nature.

Keywords

  • Black–Scholes equation
  • Brownian bridge
  • Fast Monte Carlo method
  • Time-dependent interest rate
  • Time-dependent volatility

ASJC Scopus subject areas

  • Economics, Econometrics and Finance (miscellaneous)
  • Computer Science Applications

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