Valuing American Put Options Using Gaussian Quadrature

Michael A Sullivan

The Review of Financial Studies, 2000, vol. 13, issue 1, 75-94

Abstract: This article develops an efficient and accurate method for numerical evaluation of the integral equation which defines the American put option value function. Numerical integration using Gaussian quadrature and function approximation using Chebyshev polynomials are combined to evaluate recursive expectations and produce an approximation of the option value function in two dimensions, across stock prices and over time to maturity. A set of such solutions results in a multidimensional approximation that is extremely accurate and very quick to compute. The method is an effective alternative to finite difference methods, the binomial model, and various analytic approximations. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

Date: 2000
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The Review of Financial Studies is currently edited by Itay Goldstein

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