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Closed-form approximation of American options

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  • Bjerksund, Petter
  • Stensland, Gunnar
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    Abstract

    This paper presents a closed-form approximation of the value of the finite-lived American option where the underlying asset provides a constant pay-out rate. It is derived by imposing a restriction on the set of feasible exercise strategies, and thus represents a lower bound to the option value. The exercise strategy is to exercise the option the first time the price of the underlying asset hits a flat boundary. Our numerical results show that this lower bound is very close to the true option value.

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    File URL: http://www.sciencedirect.com/science/article/pii/095652219390009H
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    Bibliographic Info

    Article provided by Elsevier in its journal Scandinavian Journal of Management.

    Volume (Year): 9 (1993)
    Issue (Month): Supplement 1 ()
    Pages: S87-S99

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    Handle: RePEc:eee:scaman:v:9:y:1993:i:supplement1:p:s87-s99

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    Web page: http://www.elsevier.com/wps/find/journaldescription.cws_home/872/description#description

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    Related research

    Keywords: American option approximation closed-form finite-lived lower bound;

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    Cited by:
    1. Francisco Venegas Martínez, 2001. "Opciones, cobertura y procesos de difusión con saltos: Una aplicación a los títulos de Gcarso," Estudios Económicos, El Colegio de México, Centro de Estudios Económicos, vol. 16(2), pages 203-226.
    2. Chorn, L.G. & Shokhor, S., 2006. "Real options for risk management in petroleum development investments," Energy Economics, Elsevier, vol. 28(4), pages 489-505, July.
    3. Jennergren, L. Peter & Naslund, Bertil, 1996. "A class of options with stochastic lives and an extension of the Black-Scholes formula," European Journal of Operational Research, Elsevier, vol. 91(2), pages 229-234, June.
    4. Jongwoo Lee & Dean Paxson, 2003. "Confined exponential approximations for the valuation of American options," The European Journal of Finance, Taylor & Francis Journals, vol. 9(5), pages 449-474.
    5. Haas, Markus & Mittnik, Stefan & Mizrach, Bruce, 2005. "Assessing central bank credibility during the EMS crises: Comparing option and spot market-based forecasts," CFS Working Paper Series 2005/09, Center for Financial Studies (CFS).
    6. Lindset, Snorre & Lund, Arne-Christian, 2007. "A Monte Carlo approach for the American put under stochastic interest rates," Journal of Economic Dynamics and Control, Elsevier, vol. 31(4), pages 1081-1105, April.
    7. Minqiang Li, Li, 2009. "Analytical Approximations for the Critical Stock Prices of American Options: A Performance Comparison," MPRA Paper 15018, University Library of Munich, Germany.
    8. Bruce Mizrach, 2007. "Recovering Probabilistic Information From Options Prices and the Underlying," Departmental Working Papers 200702, Rutgers University, Department of Economics.

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