Quantum Algorithm for Local-Volatility Option Pricing via the Kolmogorov Equation

TL;DR

This paper introduces a quantum algorithm that efficiently solves the Kolmogorov forward PDE for local-volatility models, offering potential exponential speedup in high-dimensional option pricing tasks compared to classical methods.

Contribution

The paper presents a novel quantum algorithm framework that maps the forward PDE to a Hamiltonian simulation, enabling efficient option pricing and overcoming classical dimensionality limitations.

Findings

Achieves polynomial advantage in grid size for one-dimensional problems.

Provides exponential speedup for high-dimensional basket options.

Demonstrates potential quantum advantage in complex option-pricing scenarios.

Abstract

The solution of option-pricing problems may turn out to be computationally demanding due to non-linear and path-dependent payoffs, the high dimensionality arising from multiple underlying assets, and sophisticated models of price dynamics. In this context, quantum computing has been proposed as a means to address these challenges efficiently. Prevailing approaches either simulate the stochastic differential equations governing the forward dynamics of underlying asset prices or directly solve the backward pricing partial differential equation. Here, we present an end-to-end quantum algorithmic framework that solves the Kolmogorov forward (Fokker-Planck) partial differential equation for local-volatility models by mapping it to a Hamiltonian-simulation problem via the Schr\"odingerisation technique. The algorithm specifies how to prepare the initial quantum state, perform Hamiltonian simulation, and how to efficiently recover the option price via a swap test. In particular, the efficiency of the final solution recovery is an important advantage of solving the forward versus the backward partial differential equation. Thus, our end-to-end framework offers a potential route toward quantum advantage for challenging option-pricing tasks. In particular, we obtain a polynomial advantage in grid size for the discretization of a single dimension. Nevertheless, the true power of our methodology lies in pricing high-dimensional systems, such as baskets of options, because the quantum framework admits an exponential speedup with respect to dimension, overcoming the classical curse of dimensionality.