LSV models with stochastic interest rates and correlated jumps

Abstract

Pricing and hedging exotic options using local stochastic volatility models drew a serious attention within the last decade, and nowadays became almost a standard approach to this problem. In this paper we show how this framework could be extended by adding to the model stochastic interest rates and correlated jumps in all three components. We also propose a new fully implicit modification of the popular Hundsdorfer and Verwer and Modified Craig-Sneyd finite-difference schemes which provides second order approximation in space and time, is unconditionally stable and preserves positivity of the solution, while still has a linear complexity in the number of grid nodes.