VALUING AMERICAN PUT OPTIONS USING CHEBYSHEV POLYNOMIAL APPROXIMATION

Guglielmo Maria Caporale and Mario Cerrato

Economics and Finance Discussion Papers from Economics and Finance Section, School of Social Sciences, Brunel University

Abstract: This pa per suggests a simple valuation method based on Chebyshev approximation at Chebyshev nodes to value American put options. It is similar to the approach taken in Sullivan (2000), where the option`s continuation region function is estimated by using a Chebyshev polynomial. However, in contrast to Sullivan (2000), the functional is fitted by using Chebyshev nodes. The suggested method is flexible, easy to program and efficient, and can be extended to price other types of derivative instruments. It is also applicable in other fields, providing efficient solutions to complex systems of partial differential equations. The paper also describes an alternative method based on dynamic programming and backward induction to approximate the option value in each time period.

Pages: 23 pages
Date: 2005-02
New Economics Papers: this item is included in nep-fin
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Working Paper: VALUING AMERICAN PUT OPTIONS USING CHEBYSHEV POLYNOMIAL APPROXIMATION (2005)
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