Interpolated Drift Implicit Euler MLMC Method for Barrier Option Pricing and application to CIR and CEV Models

Abstract: Recently, Giles et al. [14] proved that the efficiency of the Multilevel Monte Carlo (MLMC) method for evaluating Down-and-Out barrier options for a diffusion process $(X_t){t\in[0,T]}$ with globally Lipschitz coefficients, can be improved by combining a Brownian bridge technique and a conditional Monte Carlo method provided that the running minimum $\inf{t\in[0,T]}X_t$ has a bounded density in the vicinity of the barrier. In the present work, thanks to the Lamperti transformation technique and using a Brownian interpolation of the drift implicit Euler scheme of Alfonsi [2], we show that the efficiency of the MLMC can be also improved for the evaluation of barrier options for models with non-Lipschitz diffusion coefficients under certain moment constraints. We study two example models: the Cox-Ingersoll-Ross (CIR) and the Constant of Elasticity of Variance (CEV) processes for which we show that the conditions of our theoretical framework are satisfied under certain restrictions on the models parameters. In particular, we develop semi-explicit formulas for the densities of the running minimum and running maximum of both CIR and CEV processes which are of independent interest. Finally, numerical tests are processed to illustrate our results.