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A Forward Monte Carlo Method for American Options Pricing

✍ Scribed by DANIEL WEI-CHUNG MIAO; YUNG-HSIN LEE

Publisher
John Wiley and Sons
Year
2012
Tongue
English
Weight
728 KB
Volume
33
Category
Article
ISSN
0270-7314

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✦ Synopsis

This study proposes a forward Monte Carlo method for the pricing of American options. The main advantage of this method is that it does not use backward induction as required by other methods. Instead, the proposed approach relies on a wise determination about whether a simulated stock price has entered the exercise region. The validity of the proposed method is supported by the mathematical proofs for the vanilla cases. With some adaption, it is shown that this forward method can be extended to price other American style options such as chooser and exchange options. This study demonstrates the effectiveness of the proposed approach using a series of numerical examples, revealing significant improvements in numerical efficiency and accuracy in contrast with the standard regression‐based method of Longstaff and Schwartz (2001). Β© 2012 Wiley Periodicals, Inc. Jrl Fut Mark 33:369‐395, 2013

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