Algebraic Structure of Vector Fields in Financial Diffusion Models and its Applications

TL;DR

This paper reveals a Lie algebraic structure in financial diffusion models that enables analytical solutions to vector field flows, significantly reducing computation time in high-order SDE discretization schemes.

Contribution

The authors identify a special Lie algebraic structure in key financial models, allowing analytical flow solutions and improving computational efficiency of discretization schemes.

Findings

Analytical solutions to vector field flows are possible using the identified Lie algebraic structure.

The method drastically reduces computation time in high-order SDE discretization.

Numerical examples demonstrate significant efficiency gains.

Abstract

High order discretization schemes of SDEs by using free Lie algebra valued random variables are introduced by Kusuoka, Lyons-Victoir, Ninomiya-Victoir and Ninomiya-Ninomiya. These schemes are called KLNV methods. They involve solving the flows of vector fields associated with SDEs and it is usually done by numerical methods. The authors found a special Lie algebraic structure on the vector fields in the major financial diffusion models. Using this structure, we can solve the flows associated with vector fields analytically and efficiently. Numerical examples show that our method saves the computation time drastically.