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Barrier option simulation with Monte-Carlo Senem Kaya & Martin Pettersson Computational methods in financial mathematics 2014-10-02
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Pre-set barrier either springs the option into existence or extinguishes an already existing option. Depends on type of option Always cheaper than vanilla option, less premium Applied to different type of options. American, European, Bermudan etc.
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Up and Out European Call Option Becomes worthless if price of underlying asset increases beyond barrier
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Standard Monte-Carlo Trajectories: 100 R=0.1 Sigma=0.5 Time-steps=0.005 K=15 S 0 =12
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Visualization of barrier and value of underlying asset
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New Monte-Carlo Takes into consideration that the value could pass the barrier between two time steps Probability of passing the barrier:
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Barrier far from stock price Trajectories: 10000 B=50 R=0.1 Sigma=0.1:0.1:1 T=0.5 K=15 S 0 =12
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Barrier close to stock price Trajectories: 10000 B=17 R=0.1 Sigma=0.1:0.1:1 T=0.5 K=15 S 0 =12
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Convergence comparison
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If barrier far away, the payoff looks like European call B=17, 50, 200 R=0.1 Sigma=0.3 T=0.5 K=15 S 0 =12
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Delta - change in the price of the underlying asset to the corresponding change in the price of the derivative B=17, 50, 200 R=0.1 Sigma=0.3 T=0.5 K=15 S 0 =12
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Conclusions Easy to implement Beneficial to use new Monte-Carlo, less error New Monte-Carlo is more computationally heavy Further improvements: Study time efficiency and making it faster
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