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Computing American option prices in the lognormal jump–diffusion framework with a Markov chain

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  • Simonato, Jean-Guy
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    Abstract

    This note examines a numerical approach for computing American option prices in the lognormal jump–diffusion context. The approach uses the known transition density of the process to build a discrete-time, homogenous Markov chain to approximate the target jump–diffusion process. Numerical results showing the performance of the proposed method are examined.

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    File URL: http://www.sciencedirect.com/science/article/pii/S1544612311000031
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    Bibliographic Info

    Article provided by Elsevier in its journal Finance Research Letters.

    Volume (Year): 8 (2011)
    Issue (Month): 4 ()
    Pages: 220-226

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    Handle: RePEc:eee:finlet:v:8:y:2011:i:4:p:220-226

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    Web page: http://www.elsevier.com/locate/frl

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    Keywords: American option; Jump–diffusion; Markov chain;

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    1. S. G. Kou, 2002. "A Jump-Diffusion Model for Option Pricing," Management Science, INFORMS, vol. 48(8), pages 1086-1101, August.
    2. Duan, Jin-Chuan & Simonato, Jean-Guy, 2001. "American option pricing under GARCH by a Markov chain approximation," Journal of Economic Dynamics and Control, Elsevier, vol. 25(11), pages 1689-1718, November.
    3. Amin, Kaushik I, 1993. " Jump Diffusion Option Valuation in Discrete Time," Journal of Finance, American Finance Association, vol. 48(5), pages 1833-63, December.
    4. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
    5. Das, Sanjiv Ranjan & Sundaram, Rangarajan K., 1999. "Of Smiles and Smirks: A Term Structure Perspective," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 34(02), pages 211-239, June.
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