An ill-posed problem for the Black–Scholes equation for a profitable forecast of prices of stock options on real market data. (18th December 2015)

• Record Type: Journal Article
• Authors: Klibanov, Michael V; Kuzhuget, Andrey V; Golubnichiy, Kirill V
• Is Part Of: Inverse problems. Volume 32:Number 1(2016:Jan.)
• Publication Date: 2015-12-18
• Subjects: Black–Scholes equation -- new mathematical model -- new initial and boundary conditions -- testing on real market data -- parabolic equation with the reversed time -- Ill-posed problem -- regularization method; Inverse problems (Differential equations) -- Periodicals; 515.357
• DOI: 10.1088/0266-5611/32/1/015010
• Languages: English
• ISSNs: 0266-5611

Abstract

Abstract: A new empirical mathematical model for the Black–Scholes equation is proposed to forecast option prices. This model includes new interval for the price of the underlying stock, new initial and new boundary conditions. Conventional notions of maturity time and strike prices are not used. The Black–Scholes equation is solved as a parabolic equation with the reversed time, which is an ill-posed problem. Thus, a regularization method is used to solve it. To verify the validity of our model, real market data for 368 randomly selected liquid options are used. A new trading strategy is proposed. Our results indicates that our method is profitable on those options. Furthermore, it is shown that the performance of two simple extrapolation-based techniques is much worse. We conjecture that our method might lead to significant profits of those financial insitutions which trade large amounts of options. We caution, however, that further studies are necessary to verify this conjecture.