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Pricing the exotic: Path-dependent American options with stochastic barriers

Alejandro Rojas-Bernal and Mauricio Villamizar-Villegas ()

Latin American Journal of Central Banking (previously Monetaria), 2021, vol. 2, issue 1

Abstract: We develop a novel pricing strategy that approximates the value of an American option with exotic features through a portfolio of European options with different maturities. Among our findings, we show that: (i) our model is numerically robust in pricing plain vanilla American options; (ii) the model matches observed bids and premiums of multidimensional options that integrate ratchet, Asian, and barrier characteristics; and (iii) our closed-form approximation allows for an analytical solution of the option’s greeks, which characterize the sensitivity to various risk factors. Finally, compared to the traditional Monte Carlo simulations method, we highlight that our estimation’s prediction is more accurate and requires less than 1% of the computational time.

Keywords: Option pricing; Exotic currency options; Ratchet options; Asian options; American options; Barrier options; Weighted time value methodology; Least squares Monte Carlo (search for similar items in EconPapers)
JEL-codes: C53 E58 G13 (search for similar items in EconPapers)
Date: 2021
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Persistent link: https://EconPapers.repec.org/RePEc:eee:lajcba:v:2:y:2021:i:1:s2666143821000053

DOI: 10.1016/j.latcb.2021.100025

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Latin American Journal of Central Banking (previously Monetaria) is currently edited by Manuel Ramos-Francia

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