Optimal non-uniform finite difference grids for the Black-Scholes equations

Abstract

In this article, we present optimal non-uniform finite difference grids for the Black-Scholes (BS) equation. The finite difference method is mainly used using a uniform mesh, and it takes considerable time to price several options under the BS equation. The higher the dimension is, the worse the problem becomes. In our proposed method, we obtain an optimal non-uniform grid from a uniform grid by repeatedly removing a grid point having a minimum error based on the numerical solution on the grid including that point. We perform several numerical tests with one-, two- and three-dimensional BS equations. Computational tests are conducted for both cash-or-nothing and equity-linked security (ELS) options. The optimal non-uniform grid is especially useful in the three-dimensional case because the option prices can be efficiently computed with a small number of grid points. (C) 2020 International Association for Mathematics and Computers in Simulation (IMACS). Published by Elsevier B.V. All rights reserved.