Computational Methods for Pricing American Put Options

Y. J. Liu, G. Yin and Q. Zhang
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Y. J. Liu: Wayne State University
G. Yin: Wayne State University
Q. Zhang: University of Georgia

Journal of Optimization Theory and Applications, 2005, vol. 127, issue 2, No 9, 389-410

Abstract: Abstract This work develops computational methods for pricing American put options under a Markov-switching diffusion market model. Two methods are suggested in this paper. The first method is a stochastic approximation approach. It can handle option pricing in a finite horizon, which is particularly useful in practice and provides a systematic approach. It does not require calibration of the system parameters nor estimation of the states of the switching process. Asymptotic results of the recursive algorithms are developed. The second method is based on a selling rule for the liquidation of a stock for perpetual options. Numerical results using stochastic approximation and Monte Carlo simulation are reported. Comparisons of different methods are made.

Keywords: American put options; regime switching; boundary-value problems; stochastic approximations; stochastic optimization (search for similar items in EconPapers)
Date: 2005
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DOI: 10.1007/s10957-005-6551-8

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