On the asymptotic free boundary for the American put option problem

H. Hedenmalm

Papers from arXiv.org

Abstract: In practical work with American put options, it is important to be able to know when to exercise the option, and when not to do so. In computer simulation based on the standard theory of geometric Brownian motion for simulating stock price movements, this problem is fairly easy to handle for options with a short lifespan, by analyzing binomial trees. It is considerably more challenging to make the decision for American put options with long lifespan. In order to provide a satisfactory analysis, we look at the corresponding free boundary problem, and show that the free boundary -- which is the curve that separates the two decisions, to exercise or not to -- has an asymptotic expansion, where the coefficient of the main term is expressed as an integral in terms of the free boundary. This raises the perspective that one could use numerical simulation to approximate the integral and thus get an effective way to make correct decisions for long life options.

Date: 2004-12
References: Add references at CitEc
Citations:

Published in J. Math. Anal. Appl. 314 (2006), 345--362

Downloads: (external link)
http://arxiv.org/pdf/math/0412332 Latest version (application/pdf)

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:arx:papers:math/0412332

Access Statistics for this paper

More papers in Papers from arXiv.org
Bibliographic data for series maintained by arXiv administrators ().