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arXiv · 2306.17320

Monotone iteration scheme for nonlinear PDEs in risk models

Falko Baustian·Jan Pospíšil·Vladimír Švígler
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Abstract

In this paper we study nonlinear partial differential equations (PDEs) that are used to model different value adjustments denoted generally as xVA. These adjustments are nowadays commonly added to the risk-free financial derivative values and the PDE approach allows their easy incorporation. The aim of this paper is to apply the method of monotone iterations with sub- and supersolutions to the nonlinear Black-Scholes-type equation that occurs especially in the counterparty risk models. We introduce a monotone iteration scheme with semi-explicit solution formulas for each iteration step. Moreover, we show that the problem greatly simplifies for contracts with non-negative payoffs. To show the viability of the approach we apply our method to the call option, the forward, and the gap option.

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Falko Baustian, Jan Pospíšil, Vladimír Švígler. 2023-06-29. Monotone iteration scheme for nonlinear PDEs in risk models. https://arxiv.org/abs/2306.17320

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