A radial basis function approach to compute the first-passage probability density function in two-dimensional jump-diffusion models for financial and other applications

We consider the problem of computing the survival (first-passage) probability density function of jump-diffusion models with two stochastic factors. In particular the Fokker-Planck partial integro-differential equation associated to these models is solved using a meshless collocation approach based on radial basis functions (RBF). To enhance the computational efficiency of the method, the calculation of the jump integrals is performed using a suitable Chebyshev interpolation procedure. In addition, the RBF discretization is carried out in conjunction with an ad hoc change of variables, which allows to use radial basis functions with equally spaced centers and at the same time yields an accurate resolution of the gradients of the survival probability density function near the barrier. Numerical experiments are presented showing that the RBF approach is extremely accurate and fast, and performs significantly better than the conventional finite difference method. © 2012 Elsevier Ltd. All rights reserved.