A New Stochastic Derivative Estimator for Discontinuous Payoff Functions with Application to Financial Derivatives

Yongqiang Wang (), Michael C. Fu () and Steven I. Marcus ()
Additional contact information
Yongqiang Wang: Department of Electrical and Computer Engineering and Institute for Systems Research, University of Maryland, College Park, Maryland 20742
Michael C. Fu: The Robert H. Smith School of Business and Institute for Systems Research, University of Maryland, College Park, Maryland 20742
Steven I. Marcus: Department of Electrical and Computer Engineering and Institute for Systems Research, University of Maryland, College Park, Maryland 20742

Operations Research, 2012, vol. 60, issue 2, 447-460

Abstract: Motivated by infinitesimal perturbation analysis (IPA) and the likelihood ratio (LR) method, we derive a new unbiased stochastic derivative estimator for a class of discontinuous payoff functions that arise in many options pricing settings from finance. Our method includes IPA and the LR method as special cases and can be applied to functions of more general forms containing indicator functions. This new estimator can be computed from a single sample path or simulation, whereas existing estimators generally require additional simulations for the class of discontinuous payoff functions considered here. We apply this method to sensitivity analysis for European call options and American-style call options, and numerical experiments indicate that the estimator is computationally more efficient than other estimators.

Keywords: price sensitivity; infinitesimal perturbation analysis; simulation; derivative estimation; likelihood ratio; option pricing; stochastic approximation (search for similar items in EconPapers)
Date: 2012
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

Downloads: (external link)
http://dx.doi.org/10.1287/opre.1110.1018 (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:inm:oropre:v:60:y:2012:i:2:p:447-460

Access Statistics for this article

More articles in Operations Research from INFORMS Contact information at EDIRC.
Bibliographic data for series maintained by Chris Asher ().