Going to Extremes: Correcting Simulation Bias in Exotic Option Valuation

David R. Beaglehole, Philip Dybvig and Guofu Zhou

Financial Analysts Journal, 1997, vol. 53, issue 1, 62-68

Abstract: Monte Carlo simulation is widely used in practice to value exotic options for which analytical formulas are not available. When valuing those options that depend on extreme values of the underlying asset, convergence of the standard simulation is slow as the time grid is refined, and even a daily simulation interval produces unacceptable errors. This article suggests approximating the extreme value on a subinterval by a random draw from the known theoretical distribution for an extreme of a Brownian bridge on the same interval. This approach provides reliable option values and retains the flexibility of simulations, in that it allows great freedom in choosing a price process for the underlying asset or a joint process for the asset price, its volatility, and other asset prices.

Date: 1997
References: Add references at CitEc
Citations:

Downloads: (external link)
http://hdl.handle.net/10.2469/faj.v53.n1.2057 (text/html)
Access to full text is restricted to subscribers.

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:taf:ufajxx:v:53:y:1997:i:1:p:62-68

Ordering information: This journal article can be ordered from
http://www.tandfonline.com/pricing/journal/ufaj20

DOI: 10.2469/faj.v53.n1.2057

Access Statistics for this article

Financial Analysts Journal is currently edited by Maryann Dupes

More articles in Financial Analysts Journal from Taylor & Francis Journals
Bibliographic data for series maintained by Chris Longhurst ().