medium · Quantitative Finance numerical
A trader uses an explicit finite difference scheme to price a call option.
If the coefficents in the update equation V_i^n = aV_i-1^n+1 + bV_i^n+1 + cV_i+1^n+1 are a = 0.4875, b = -0.0005, and c = 0.5125, what does the value of b indicate about the stability of the grid?
- The grid is stable because the magnitude of b is very small.
- The grid is unstable because b is negative.
- The grid is stable because the coefficients sum to 1.0.
- The grid is unstable because a and c are too large.
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