Fast estimation of true bounds on Bermudan option prices under jump-diffusion processes

Helin Zhu, Fan Ye and Enlu Zhou

Quantitative Finance, 2015, vol. 15, issue 11, 1885-1900

Abstract: Fast pricing of American-style options has been a difficult problem since it was first introduced to the financial markets in 1970s, especially when the underlying stocks' prices follow some jump-diffusion processes. In this paper, we extend the 'true martingale algorithm' proposed by Belomestny et al. [ Math. Finance , 2009, 19 , 53-71] for the pure-diffusion models to the jump-diffusion models, to fast compute true tight upper bounds on the Bermudan option price in a non-nested simulation manner. By exploiting the martingale representation theorem on the optimal dual martingale driven by jump-diffusion processes, we are able to explore the unique structure of the optimal dual martingale and construct an approximation that preserves the martingale property. The resulting upper bound estimator avoids the nested Monte Carlo simulation suffered by the original primal-dual algorithm, therefore significantly improving the computational efficiency. Theoretical analysis is provided to guarantee the quality of the martingale approximation. Numerical experiments are conducted to verify the efficiency of our algorithm.

Date: 2015
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DOI: 10.1080/14697688.2014.971520

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