On local analytic expansions of densities in the context of (micro-)hypoelliptic and classes of semi-elliptic equations

Joerg Kampen

Published 2010-12-02, updated 2010-12-06Version 2

Explicit representations of densities for linear parabolic partial differential equations are useful in order to design computation schemes of high accuracy for a considerable class of diffusion models. Approximations of lower order based on the WKB-expansion have been used in order to compute Greeks in standard models of the interest rate market (cf. [2]). However, it turns out that for higher order approximations another related expansion leads to more accurate schemes. We compute a local explicit formula for a class of parabolic problems and determine a lower bound of the time horizon where it holds (given a certain bounded domain). Although the local analytic expansions hold only for strictly elliptic equations we show that the expansions can be used in order to design higher order schemes for various types of (micro)-hypoelliptic and semi-elliptic equations, e.g. the reduced market models considered in [7] or front fixing schemes for multivariate American derivatives [3].