The Euler-Maruyama approximations for the CEV model

Original · EN

The CEV model is given by the stochastic differential equation Xₜ=X₀+∫₀ᵗμXₛds+∫₀ᵗσ(X+ₛ)ᵖdWₛ, 1/2≤ p<1. It features a non-Lipschitz diffusion coefficient and gets absorbed at zero with a positive probability. We show the weak convergence of Euler-Maruyama approximations Xₜⁿ to the process Xₜ, 0≤ t≤ T, in the Skorokhod metric. We give a new approximation by continuous processes which allows to relax some technical conditions in the proof of weak convergence in HZa done in terms of discrete time martingale problem. We calculate ruin probabilities as an example of such approximation. We establish that the ruin probability evaluated by simulations is not guaranteed to converge to the theoretical one, because the point zero is a discontinuity point of the limiting distribution. To establish such convergence we use the Levy metric, and also confirm the convergence numerically. Although the result is given for the specific model, our method works in a more general case of non-Lipschitz diffusion with absorbtion.