An ETD method for American options under the Heston model

Abstract

A numerical method for American options pricing on assets under the Heston stochastic volatility model is developed. A preliminary transformation is applied to remove the mixed derivative term avoiding known numerical drawbacks and reducing computational costs. Free boundary is treated by the penalty method. Transformed nonlinear partial differential equation is solved numerically by using the method of lines. For full discretization the exponential time differencing method is used. Numerical analysis establishes the stability and positivity of the proposed method. The numerical convergence behaviour and effectiveness are investigated in extensive numerical experiments.