Exact Simulation of Bessel Diffusions

Roman N. Makarov; Devin Glew

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arXiv · 0910.4177

Exact Simulation of Bessel Diffusions

Roman N. Makarov·Devin Glew

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Abstract

We consider the exact path sampling of the squared Bessel process and some other continuous-time Markov processes, such as the CIR model, constant elasticity of variance diffusion model, and hypergeometric diffusions, which can all be obtained from a squared Bessel process by using a change of variable, time and scale transformation, and/or change of measure. All these diffusions are broadly used in mathematical finance for modelling asset prices, market indices, and interest rates. We show how the probability distributions of a squared Bessel bridge and a squared Bessel process with or without absorption at zero are reduced to randomized gamma distributions. Moreover, for absorbing stochastic processes, we develop a new bridge sampling technique based on conditioning on the first hitting time at zero. Such an approach allows us to simplify simulation schemes. New methods are illustrated with pricing path-dependent options.

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Roman N. Makarov, Devin Glew. 2009-10-21. Exact Simulation of Bessel Diffusions. https://arxiv.org/abs/0910.4177

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