Simulation of volatility modulated Volterra processes using hyperbolic stochastic partial differential equations

TL;DR

This paper introduces a finite difference scheme for simulating hyperbolic stochastic PDEs that model complex processes like turbulence and electricity prices, demonstrating convergence and practical application in energy finance.

Contribution

The paper presents a novel finite difference method for hyperbolic SPDEs, enabling accurate simulation of VMV and LSS processes with proven convergence.

Findings

Finite difference scheme converges as partitions become finer.

Method successfully applied to energy finance example.

Provides a new computational tool for complex stochastic processes.

Abstract

We propose a finite difference scheme to simulate solutions to a certain type of hyperbolic stochastic partial differential equation (HSPDE). These solutions can in turn estimate so called volatility modulated Volterra (VMV) processes and L\'{e}vy semistationary (LSS) processes, which is a class of processes that have been employed to model turbulence, tumor growth and electricity forward and spot prices. We will see that our finite difference scheme converges to the solution of the HSPDE as we take finer and finer partitions for our finite difference scheme in both time and space. Finally, we demonstrate our method with an example from the energy finance literature.