Pricing American Options on Jump-Diffusion Processes using Fourier Hermite Series Expansions

Carl Chiarella and Andrew Ziogas

No 145, Research Paper Series from Quantitative Finance Research Centre, University of Technology, Sydney

Abstract: This paper presents a numerical method for pricing American call options where the underlying asset price follows a jump-diffusion process. The method is based on the Fourier-Hermite series expansions of Chiarella, El-Hassan & Kucera (1999), which we extend to allow for Poisson jumps, in the case where the jump sizes are log-normally distributed. The series approximation is applied to both European and American call options, and algorithms are presented for calculating the option price in each case. Since the series expansions only require discretisation in time to be implemented, the resulting price approximations require no asset price interpolation, and for certain maturities are demonstrated to produce both accurate and efficient solutions when compared with alternative methods, such as numerical integration, the method of lines and finite difference schemes.

Keywords: American options; jump-di usion; Fourier-Hermite series expansions; free boundary problem (search for similar items in EconPapers)
JEL-codes: C61 D11 (search for similar items in EconPapers)
Pages: 48 pages
Date: 2005-01-01
New Economics Papers: this item is included in nep-cfn
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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https://www.uts.edu.au/sites/default/files/qfr-archive-02/QFR-rp145.pdf (application/pdf)

Related works:
Working Paper: Pricing American Options on Jump-Diffusion Processes using Fourier-Hermite Series Expansions (2004)
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Persistent link: https://EconPapers.repec.org/RePEc:uts:rpaper:145

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