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Paper No. 07-26

Download 07-26

B Cassella and GO Roberts

Exact Monte Carlo Simulation of Killed Diffusions

Date: November 2007

Abstract: We describe and implement a novel methodology for Monte Carlo simulation of one-dimensional killed diffusions. The proposed estimators represent an unbiased and efficient alternative to current Monte Carlo estimators based on discretization methods for the cases when the finitedimensional distributions of the process are unknown. For barrier option pricing in finance, we design a suitable Monte Carlo algorithm both for the single barrier case and the double barrier case. Results from numerical investigations are in excellent agreement with the theoretical predictions.