A very efficient approach to compute the first-passage probability density function in a time-changed Brownian model: Applications in finance

• A time-changed Brownian model is considered.
• A method to compute the first-passage probability density function is proposed.
• Several applications in finance are presented.
• The proposed method is extremely accurate and fast.
• The proposed approach performs much better than the finite difference method.

We propose a numerical method to compute the first-passage probability density function in a time-changed Brownian model. In particular, we derive an integral representation of such a density function in which the integrand functions must be obtained solving a system of Volterra equations of the first kind. In addition, we develop an ad-hoc numerical procedure to regularize and solve this system of integral equations.The proposed method is tested on three application problems of interest in mathematical finance, namely the calculation of the survival probability of an indebted firm, the pricing of a single-knock-out put option and the pricing of a double-knock-out put option. The results obtained reveal that the novel approach is extremely accurate and fast, and performs significantly better than the finite difference method.