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In this paper we develop a numerical method for pricing American options under regime-switching model, whose solutions are option buyer indifference prices. The problem is formulated as a nonlinear complementarity problem. We apply interior penalty method to approximate the differential complementarity problem, which results in a system of one degenerate parabolic equation and one ordinary differential equation, weakly coupled by nonlinear exponential term. We formulate the problems in variational form in appropriate spaces and prove comparison principle. Then, as a consequence, we derive estimates about the convergence rate of the interior penalty method. We discretize the penalized problem by fully implicit finite difference scheme and prove that the early exercise constraint is strictly satisfied. We establish comparison principle, uniqueness and boundedness of the numerical solution. To solve the nonlinear system of algebraic equations we use Newton method and partial Newton method. We present numerical results that confirm the theoretical statements. To improve the computational efficiency, we unfold the two-grid idea, combining both iteration processes – Newton method and partial Newton method. We illustrate the efficiency of this approach. [ABSTRACT FROM AUTHOR]

Abstract: In this paper, on the basis of Newton’s method, we propose a fast quasilinearization numerical scheme, coupled with Rothe’s method, for fully nonlinear parabolic equations. General conditions that provide quadratic, uniform and monotone convergence of the quasilinearization method (QLM) of solving fully nonlinear ordinary differential equations that arise on each time level, are formulated and elaborated. The convergence of QLM and its rate are examined numerically, on a simple test example with an exact solution. The first few iterations already provide extremely accurate and stable numerical results. The second goal is to consider three applications of the proposed schemes in financial mathematics. Namely, numerical results for three nonlinear problems of optimal investment are presented and discussed. The numerical experiments of the last problem are based on the data from statistic information of the Bulgarian National Bank and Bratislava Interbank. [Copyright &y& Elsevier]