# simByMilstein

Simulate diagonal diffusion `Merton`

sample paths by Milstein
approximation

*Since R2023a*

## Syntax

## Description

`[`

simulates `Paths`

,`Times`

,`Z`

,`N`

] = simByMilstein(`MDL`

,`NPeriods`

)`NTrials`

sample paths of `NVars`

correlated state variables driven by `NBrowns`

Brownian motion
sources of risk and `NJumps`

compound Poisson processes
representing the arrivals of important events over `NPeriods`

consecutive observation periods. The simulation approximates the continuous-time
Merton jump diffusion process by the Milstein approach.

`[`

specifies options using one or more name-value pair arguments in addition to the
input arguments in the previous syntax.`Paths`

,`Times`

,`Z`

,`N`

] = simByMilstein(___,`Name=Value`

)

You can perform quasi-Monte Carlo simulations using the name-value arguments for
`MonteCarloMethod`

, `QuasiSequence`

, and
`BrownianMotionMethod`

. For more information, see Quasi-Monte Carlo Simulation.

## Examples

### Quasi-Monte Carlo Simulation with Milstein Scheme Using Merton Model

This example shows how to use `simByMilstein`

with a Merton model to perform a quasi-Monte Carlo simulation. Quasi-Monte Carlo simulation is a Monte Carlo simulation that uses quasi-random sequences instead pseudo random numbers.

Define the parameters for the `merton`

object.

AssetPrice = 80; Return = 0.03; Sigma = 0.16; JumpMean = 0.02; JumpVol = 0.08; JumpFreq = 2;

Create a `merton`

object.

mertonObj = merton(Return,Sigma,JumpFreq,JumpMean,JumpVol,StartState=AssetPrice)

mertonObj = Class MERTON: Merton Jump Diffusion ---------------------------------------- Dimensions: State = 1, Brownian = 1 ---------------------------------------- StartTime: 0 StartState: 80 Correlation: 1 Drift: drift rate function F(t,X(t)) Diffusion: diffusion rate function G(t,X(t)) Simulation: simulation method/function simByEuler Sigma: 0.16 Return: 0.03 JumpFreq: 2 JumpMean: 0.02 JumpVol: 0.08

Perform a quasi-Monte Carlo simulation by using `simByMilstein`

with the optional name-value arguments for `MonteCarloMethod`

, `QuasiSequence`

, and `BrownianMotionMethod`

.

[paths,times] = simByMilstein(mertonObj,10,Ntrials=4096,MonteCarloMethod="quasi",QuasiSequence="sobol",BrownianMotionMethod="principal-components");

## Input Arguments

`MDL`

— Stochastic differential equation model

`Merton`

object

Stochastic differential equation model, specified as a
`merton`

object. You can create a
`merton`

object using `merton`

.

**Data Types: **`object`

`NPeriods`

— Number of simulation periods

positive scalar integer

Number of simulation periods, specified as a positive scalar integer. The
value of `NPeriods`

determines the number of rows of the
simulated output series.

**Data Types: **`double`

### Name-Value Arguments

Specify optional pairs of arguments as
`Name1=Value1,...,NameN=ValueN`

, where `Name`

is
the argument name and `Value`

is the corresponding value.
Name-value arguments must appear after other arguments, but the order of the
pairs does not matter.

**Example: **```
[Paths,Times,Z,N] =
simByMilstein(Merton_obj,NPeriods,NTrials=1000,DeltaTime=dt,NSteps=10)
```

`NTrials`

— Simulated trials (sample paths)

`1`

(single path of correlated state
variables) (default) | positive scalar integer

Simulated trials (sample paths) of `NPeriods`

observations each, specified as the comma-separated pair consisting of
`'NTrials'`

and a positive scalar integer.

**Data Types: **`double`

`DeltaTime`

— Positive time increments between observations

`1`

(default) | scalar | column vector

Positive time increments between observations, specified as the
comma-separated pair consisting of `'DeltaTime'`

and a
scalar or a `NPeriods`

-by-`1`

column
vector.

`DeltaTime`

represents the familiar
*dt* found in stochastic differential equations,
and determines the times at which the simulated paths of the output
state variables are reported.

**Data Types: **`double`

`NSteps`

— Number of intermediate time steps within each time increment

`1`

(indicating no intermediate
evaluation) (default) | positive scalar integer

Number of intermediate time steps within each time increment
*dt* (specified as `DeltaTime`

),
specified as the comma-separated pair consisting of
`'NSteps'`

and a positive scalar integer.

The `simByEuler`

function partitions each time
increment *dt* into `NSteps`

subintervals of length *dt*/`NSteps`

,
and refines the simulation by evaluating the simulated state vector at
`NSteps − 1`

intermediate points. Although
`simByEuler`

does not report the output state
vector at these intermediate points, the refinement improves accuracy by
allowing the simulation to more closely approximate the underlying
continuous-time process.

**Data Types: **`double`

`Antithetic`

— Flag to use antithetic sampling to generate the Gaussian random variates

`false`

(no antithetic
sampling) (default) | logical with values `true`

or
`false`

Flag to use antithetic sampling to generate the Gaussian random
variates that drive the Brownian motion vector (Wiener processes),
specified as the comma-separated pair consisting of
`'Antithetic'`

and a scalar numeric or logical
`1`

(`true`

) or
`0`

(`false`

).

When you specify `true`

,
`simByEuler`

performs sampling such that all
primary and antithetic paths are simulated and stored in successive
matching pairs:

Odd trials

`(1,3,5,...)`

correspond to the primary Gaussian paths.Even trials

`(2,4,6,...)`

are the matching antithetic paths of each pair derived by negating the Gaussian draws of the corresponding primary (odd) trial.

**Note**

If you specify an input noise process (see
`Z`

), `simByEuler`

ignores the
value of `Antithetic`

.

**Data Types: **`logical`

`Z`

— Direct specification of the dependent random noise process for generating Brownian motion vector

generates correlated Gaussian variates based on the
`Correlation`

member of the `SDE`

object (default) | function | three-dimensional array of dependent random variates

Direct specification of the dependent random noise process for
generating the Brownian motion vector (Wiener process) that drives the
simulation, specified as the comma-separated pair consisting of
`'Z'`

and a function or as an ```
(NPeriods ⨉
NSteps)
```

-by-`NBrowns`

-by-`NTrials`

three-dimensional array of dependent random variates.

**Note**

If you specify `Z`

as a function, it must return
an `NBrowns`

-by-`1`

column vector,
and you must call it with two inputs:

A real-valued scalar observation time

*t*An

`NVars`

-by-`1`

state vector*X*_{t}

**Data Types: **`double`

| `function`

`N`

— Dependent random counting process for generating number of jumps

random numbers from Poisson distribution with
parameter `JumpFreq`

from `merton`

object (default) | three-dimensional array | function

Dependent random counting process for generating the number of jumps,
specified as the comma-separated pair consisting of
`'N'`

and a function or an
(`NPeriods`

⨉ `NSteps`

)
-by-`NJumps`

-by-`NTrials`

three-dimensional array of dependent random variates.

If you specify a function, `N`

must return an
`NJumps`

-by-`1`

column vector, and
you must call it with two inputs: a real-valued scalar observation time
*t* followed by an
`NVars`

-by-`1`

state vector
*X _{t}*.

**Data Types: **`double`

| `function`

`StorePaths`

— Flag that indicates how `Paths`

is stored and returned

`true`

(default) | logical with values `true`

or
`false`

Flag that indicates how the output array `Paths`

is
stored and returned, specified as the comma-separated pair consisting of
`'StorePaths'`

and a scalar numeric or logical
`1`

(`true`

) or
`0`

(`false`

).

If

`StorePaths`

is`true`

(the default value) or is unspecified,`simByEuler`

returns`Paths`

as a three-dimensional time series array.If

`StorePaths`

is`false`

(logical`0`

),`simByEuler`

returns`Paths`

as an empty matrix.

**Data Types: **`logical`

`MonteCarloMethod`

— Monte Carlo method to simulate stochastic processes

`"standard"`

(default) | string with values `"standard"`

,
`"quasi"`

, or
`"randomized-quasi"`

| character vector with values `'standard'`

,
`'quasi'`

, or
`'randomized-quasi'`

Monte Carlo method to simulate stochastic processes, specified as the
comma-separated pair consisting of `'MonteCarloMethod'`

and a string or character vector with one of the following values:

`"standard"`

— Monte Carlo using pseudo random numbers`"quasi"`

— Quasi-Monte Carlo using low-discrepancy sequences`"randomized-quasi"`

— Randomized quasi-Monte Carlo

**Note**

If you specify an input noise process (see `Z`

and `N`

), `simByEuler`

ignores
the value of `MonteCarloMethod`

.

**Data Types: **`string`

| `char`

`QuasiSequence`

— Low discrepancy sequence to drive the stochastic processes

`"sobol"`

(default) | string with value `"sobol"`

| character vector with value `'sobol'`

Low discrepancy sequence to drive the stochastic processes, specified
as the comma-separated pair consisting of
`'QuasiSequence'`

and a string or character vector
with the following value:

`"sobol"`

— Quasi-random low-discrepancy sequences that use a base of two to form successively finer uniform partitions of the unit interval and then reorder the coordinates in each dimension.

**Note**

If `MonteCarloMethod`

option is not specified
or specified as`"standard"`

,
`QuasiSequence`

is ignored.

**Data Types: **`string`

| `char`

`BrownianMotionMethod`

— Brownian motion construction method

`"standard"`

(default) | string with value `"brownian-bridge"`

or
`"principal-components"`

| character vector with value `'brownian-bridge'`

or
`'principal-components'`

Brownian motion construction method, specified as the comma-separated
pair consisting of `'BrownianMotionMethod'`

and a
string or character vector with one of the following values:

`"standard"`

— The Brownian motion path is found by taking the cumulative sum of the Gaussian variates.`"brownian-bridge"`

— The last step of the Brownian motion path is calculated first, followed by any order between steps until all steps have been determined.`"principal-components"`

— The Brownian motion path is calculated by minimizing the approximation error.

**Note**

If an input noise process is specified using the
`Z`

input argument,
`BrownianMotionMethod`

is ignored.

The starting point for a Monte Carlo simulation is the construction of a Brownian motion sample path (or Wiener path). Such paths are built from a set of independent Gaussian variates, using either standard discretization, Brownian-bridge construction, or principal components construction.

Both standard discretization and Brownian-bridge construction share
the same variance and, therefore, the same resulting convergence when
used with the `MonteCarloMethod`

using pseudo random
numbers. However, the performance differs between the two when the
`MonteCarloMethod`

option
`"quasi"`

is introduced, with faster convergence
for the `"brownian-bridge"`

construction option and the
fastest convergence for the `"principal-components"`

construction option.

**Data Types: **`string`

| `char`

`Processes`

— Sequence of end-of-period processes or state vector adjustments

`simByEuler`

makes no adjustments and
performs no processing (default) | function | cell array of functions

Sequence of end-of-period processes or state vector adjustments,
specified as the comma-separated pair consisting of
`'Processes'`

and a function or cell array of
functions of the form

$${X}_{t}=P(t,{X}_{t})$$

The `simByEuler`

function runs processing functions
at each interpolation time. The functions must accept the current
interpolation time *t*, and the current state vector
*X _{t}*
and return a state vector that can be an adjustment to the input
state.

If you specify more than one processing function,
`simByEuler`

invokes the functions in the order in
which they appear in the cell array. You can use this argument to
specify boundary conditions, prevent negative prices, accumulate
statistics, plot graphs, and more.

The end-of-period `Processes`

argument allows you to
terminate a given trial early. At the end of each time step,
`simByEuler`

tests the state vector
*X _{t}* for an
all-

`NaN`

condition. Thus, to signal an early
termination of a given trial, all elements of the state vector
*X*must be

_{t}`NaN`

. This test enables you to define a
`Processes`

function to signal early termination of
a trial, and offers significant performance benefits in some situations
(for example, pricing down-and-out barrier options).**Data Types: **`cell`

| `function`

## Output Arguments

`Paths`

— Simulated paths of correlated state variables

array

Simulated paths of correlated state variables, returned as an
```
(NPeriods +
1)
```

-by-`NVars`

-by-`NTrials`

three-dimensional time series array.

For a given trial, each row of `Paths`

is the transpose
of the state vector
*X*_{t} at time
*t*. When `StorePaths`

is set to
`false`

, `simByEuler`

returns
`Paths`

as an empty matrix.

`Times`

— Observation times associated with simulated paths

column vector

Observation times associated with the simulated paths, returned as an
`(NPeriods + 1)`

-by-`1`

column vector.
Each element of `Times`

is associated with the
corresponding row of `Paths`

.

`Z`

— Dependent random variates for generating Brownian motion vector

array

Dependent random variates used to generate the Brownian motion vector
(Wiener processes) that drive the simulation, returned as an
```
(NPeriods ⨉
NSteps)
```

-by-`NBrowns`

-by-`NTrials`

three-dimensional time-series array.

`N`

— Dependent random variates used for generating jump counting process vector

array

Dependent random variates for generating the jump counting process vector,
returned as an ```
(NPeriods ⨉
NSteps)
```

-by-`NJumps`

-by-`NTrials`

three-dimensional time-series array.

## More About

### Milstein Method

The *Milstein method* is a numerical method
for approximating solutions to stochastic differential equations (SDEs).

The Milstein method is an extension of the Euler-Maruyama method, which is a first-order numerical method for SDEs. The Milstein method adds a correction term to the Euler-Maruyama method that takes into account the second-order derivative of the SDE. This correction term improves the accuracy of the approximation, especially for SDEs with non-linearities.

### Antithetic Sampling

Simulation methods allow you to specify a popular
*variance reduction* technique called *antithetic
sampling*.

This technique attempts to replace one sequence of random observations with
another that has the same expected value but a smaller variance. In a typical Monte
Carlo simulation, each sample path is independent and represents an independent
trial. However, antithetic sampling generates sample paths in pairs. The first path
of the pair is referred to as the *primary path*, and the second
as the *antithetic path*. Any given pair is independent other
pairs, but the two paths within each pair are highly correlated. Antithetic sampling
literature often recommends averaging the discounted payoffs of each pair,
effectively halving the number of Monte Carlo trials.

This technique attempts to reduce variance by inducing negative dependence between paired input samples, ideally resulting in negative dependence between paired output samples. The greater the extent of negative dependence, the more effective antithetic sampling is.

## Algorithms

This function simulates any vector-valued SDE of the following form:

$$d{X}_{t}=B(t,{X}_{t}){X}_{t}dt+D(t,{X}_{t})V(t,{x}_{t})d{W}_{t}+Y(t,{X}_{t},{N}_{t}){X}_{t}d{N}_{t}$$

Here:

*X*is an_{t}`NVars`

-by-`1`

state vector of process variables.*B*(*t*,*X*_{t}) is an`NVars`

-by-`NVars`

matrix of generalized expected instantaneous rates of return.

is an*D*(*t*,*X*_{t})`NVars`

-by-`NVars`

diagonal matrix in which each element along the main diagonal is the corresponding element of the state vector.

is an*V*(*t*,*X*_{t})`NVars`

-by-`NVars`

matrix of instantaneous volatility rates.*dW*_{t}is an`NBrowns`

-by-`1`

Brownian motion vector.

is an*Y*(*t*,*X*_{t},*N*_{t})`NVars`

-by-`NJumps`

matrix-valued jump size function.*dN*_{t}is an`NJumps`

-by-`1`

counting process vector.

`simByEuler`

simulates `NTrials`

sample paths of
`NVars`

correlated state variables driven by
`NBrowns`

Brownian motion sources of risk over
`NPeriods`

consecutive observation periods, using the Euler
approach to approximate continuous-time stochastic processes.

Consider the process *X* satisfying a stochastic differential
equation of the form.

$$d{X}_{t}=\mu ({X}_{t})dt+\sigma ({X}_{t})d{W}_{t}$$

The attempt of including a term of *O*(*dt*) in the
drift refines the Euler scheme and results in the algorithm derived by Milstein [1].

$${X}_{t+1}={X}_{t}+\mu ({X}_{t})dt+\sigma ({X}_{t})d{W}_{t}+\frac{1}{2}\sigma ({X}_{t}){\sigma}^{/}({X}_{t})(d{W}_{t}^{2}-dt)$$

## References

[1] Milstein, G.N. "A Method of
Second-Order Accuracy Integration of Stochastic Differential
Equations."*Theory of Probability and Its Applications*, 23,
1978, pp. 396–401.

## Version History

**Introduced in R2023a**

## MATLAB Command

You clicked a link that corresponds to this MATLAB command:

Run the command by entering it in the MATLAB Command Window. Web browsers do not support MATLAB commands.

Select a Web Site

Choose a web site to get translated content where available and see local events and offers. Based on your location, we recommend that you select: .

You can also select a web site from the following list:

## How to Get Best Site Performance

Select the China site (in Chinese or English) for best site performance. Other MathWorks country sites are not optimized for visits from your location.

### Americas

- América Latina (Español)
- Canada (English)
- United States (English)

### Europe

- Belgium (English)
- Denmark (English)
- Deutschland (Deutsch)
- España (Español)
- Finland (English)
- France (Français)
- Ireland (English)
- Italia (Italiano)
- Luxembourg (English)

- Netherlands (English)
- Norway (English)
- Österreich (Deutsch)
- Portugal (English)
- Sweden (English)
- Switzerland
- United Kingdom (English)