An obstacle problem arising from American options pricing: regularity of solutions

Abstract

We analyse the obstacle problem for the nonlocal parabolic operator \[\partial_t u + (-Δ)^{s} u - b \cdot \nabla u - \mathcal{I}u - ru,\] where $b\in {\mathbb{R}}^n$, $r\in \mathbb{R}$, and $\mathcal{I}$ is a nonlocal lower order diffusion operator with respect to the fractional Laplace operator $(-\Delta {)}^s$. This model appears in the study of American options pricing when the stochastic process governing the stock price is assumed to be a purely jump process. We study the existence and the uniqueness of solutions to the obstacle problem, and we prove optimal regularity of solutions in space, and almost optimal regularity in time.

37 pages