Method of Reducing Dimension of Space Variables in Multi-dimensional Black-Scholes Equations

Abstract

We study a method of reducing space dimension in multi-dimensionalBlack-Scholes partial differential equations as well as in multi-dimensional parabolic equations. We prove that a multiplicative transformation of space variables in the Black-Scholes partial differential equation reserves the form of Black-Scholes partial differential equation and reduces the space dimension. We show that this transformation can reduce the number of sources of risks by two or more in some cases by giving remarks and several examples of financial pricing problems. We also present that the invariance of the form of Black-Scholes equations is based on the invariance of the form of parabolic equation under a change of variables with the linear combination of variables. Keywords : Black-Scholes equations;Multi-dimensional; Reducing dimension; Options; Foreign currency strike price; Basket option; Foreign currency option; Zero coupon bond derivative. 2010 Mathematics Subject Classification: 35K15, 91B24.