Monte Carlo Valuation of American Options through Computation of the Optimal Exercise Frontier

Alfredo Ibáñez () and Fernando Zapatero

Journal of Financial and Quantitative Analysis, 2004, vol. 39, issue 2, 253-275

Abstract: This paper introduces a Monte Carlo simulation method for pricing multidimensional American options based on the computation of the optimal exercise frontier. We consider Bermudan options that can be exercised at a finite number of times and compute the optimal exercise frontier recursively. We show that for every date of possible exercise, any single point of the optimal exercise frontier is a fixed point of a simple algorithm. Once the frontier is computed, we use plain vanilla Monte Carlo simulation to price the option and obtain a low-biased estimator. We illustrate the method with applications to several types of options.

Date: 2004
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