ALTERNATIVE RANDOMIZATION FOR VALUING AMERICAN OPTIONS

Toshikazu Kimura ()
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Toshikazu Kimura: Graduate School of Economics and Business Administration, Hokkaido University, Kita 9, Nishi 7, Kita-ku, Sapporo 060-0809, Japan

Asia-Pacific Journal of Operational Research (APJOR), 2010, vol. 27, issue 02, 167-187

Abstract: This paper deals with randomization methods for valuing American options written on dividend-paying assets, which are based on the idea of treating the maturity date as a random variable. In the randomization method introduced by Carr in 1998, he used the Erlangian distributed random variable to develop a recursive algorithm starting from the so-called Canadian option with an exponentially distributed random maturity. The purposes of this paper are (i) to provide much simpler pricing formulas for the Canadian option; (ii) to interpret the Gaver–Stehfest method developed for inverting Laplace transforms as an alternative randomization method in the context of valuing American options; and (iii) to evaluate the performance of the Gaver–Stehfest method in details with theoretical and numerical views. Numerical experiments indicate that the Gaver–Stehfest method works well to generate accurate approximations for the early exercise boundary as well as the option value.

Keywords: American options; randomization; Canadian options; Laplace transforms; Gaver–Stehfest method (search for similar items in EconPapers)
Date: 2010
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Citations: View citations in EconPapers (5)

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Persistent link: https://EconPapers.repec.org/RePEc:wsi:apjorx:v:27:y:2010:i:02:n:s0217595910002624

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DOI: 10.1142/S0217595910002624

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