Fast and accurate calculation of American option prices

Luca Vincenzo Ballestra

Decisions in Economics and Finance, 2018, vol. 41, issue 2, No 16, 399-426

Abstract: Abstract We propose a very efficient numerical method to solve a nonlinear partial differential problem that is encountered in the pricing of American options. In particular, by using the front-fixing approach originally developed in Wu and Kwok (J Financ Eng 6:83–97, 1997) and Nielsen et al. (J Comput Finance 5:69–97, 2002) in conjunction with a suitable change of the time variable, a (nonlinear) partial differential problem is obtained which can be solved very efficiently by means of a finite difference scheme enhanced by repeated Richardson extrapolation. Numerical results are presented showing that the novel algorithm yields excellent results, and performs significantly better than a finite different method with Bermudan approximation.

Keywords: American option; Front-fixing; Richardson extrapolation; Free-boundary problem (search for similar items in EconPapers)
JEL-codes: C6 G13 (search for similar items in EconPapers)
Date: 2018
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Citations: View citations in EconPapers (4)

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DOI: 10.1007/s10203-018-0224-1

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