New Splitting Scheme for Pricing American Options Under the Heston Model

Maryam Safaei (), Abodolsadeh Neisy () and Nader Nematollahi ()
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Maryam Safaei: Islamic Azad University
Abodolsadeh Neisy: Allameh Tabataba’i University
Nader Nematollahi: Allameh Tabataba’i University

Computational Economics, 2018, vol. 52, issue 2, No 4, 405-420

Abstract: Abstract In this paper, we present a new splitting scheme for pricing the American options under the Heston model. For this purpose, first the price of American put option is modeled, which its underlying asset value follows Heston’s stochastic volatility model , and then it is formulated as a linear complementarity problem (LCP) involving partial differential operator. By using new splitting scheme, the partial differential operator is decomposed into simpler operators in several fractional time steps. These operators are implicitly expressed in the implicit Adams–Moulton method. Then, the two-dimensional LCP is decomposed into three LCPs based on these operators. Each LCP is solved numerically in two steps. The numerical results obtained for the American option pricing problem based on the Heston model are compared with the reference results.

Keywords: American option pricing; Heston model; Linear complementarity problem; Splitting scheme; 91B25; 91B70; 90-08 (search for similar items in EconPapers)
Date: 2018
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Citations: View citations in EconPapers (2)

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DOI: 10.1007/s10614-017-9686-4

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