Valuing American options using fast recursive projections

Antonio Cosma (), Stefano Galluccio, Paola Pederzoli and Olivier Scaillet
Additional contact information
Stefano Galluccio: Incipit Capital, London
Paola Pederzoli: University of Geneva and Swiss Finance Institute

DEM Discussion Paper Series from Department of Economics at the University of Luxembourg

Abstract: We introduce a fast and widely applicable numerical pricing method that uses recursive projections. We characterize its convergence speed. We find that the early exercise boundary of an American call option on a discrete dividend paying stock is higher under the Merton and Heston models than under the Black-Scholes model, as opposed to the continuous dividend case. A large database of call options on stocks with quarterly dividends shows that adding stochastic volatility and jumps to the Black-Scholes benchmark reduces the amount foregone by call holders failing to optimally exercise by 25%. Transaction fees cannot fully explain the suboptimal behavior.

Keywords: Option pricing; American option; Bermudan option; discrete transform; discrete dividend paying stock; suboptimal non-exercise; numerical techniques (search for similar items in EconPapers)
JEL-codes: C63 G13 (search for similar items in EconPapers)
Date: 2015
New Economics Papers: this item is included in nep-cmp and nep-ore
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https://hdl.handle.net/10993/25355 (application/pdf)

Related works:
Working Paper: Valuing American options using fast recursive projections (2016)
Working Paper: Valuing American Options Using Fast Recursive Projections (2012)
Working Paper: Valuing American options using fast recursive projections (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:luc:wpaper:15-20

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