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Using forward Monte-Carlo simulation for the valuation of American barrier options

Author

Listed:
  • Daniel Wei-Chung Miao

    (National Taiwan University of Science and Technology)

  • Yung-Hsin Lee

    (Lunghwa University of Science and Technology)

  • Jr-Yan Wang

    (National Taiwan University)

Abstract

This paper extends the forward Monte-Carlo methods, which have been developed for the basic types of American options, to the valuation of American barrier options. The main advantage of these methods is that they do not require backward induction, the most time-consuming and memory-intensive step in the simulation approach to American options pricing. For these methods to work, we need to define the so-called pseudo critical prices which are used to determine whether early exercise should happen. In this study, we define a new and more flexible version of the pseudo critical prices which can be conveniently extended to all fourteen types of American barrier options. These pseudo critical prices are shown to satisfy the criteria of a sufficient indicator which guarantees the effectiveness of the proposed methods. A series of numerical experiments are provided to compare the performance between the forward and backward Monte-Carlo methods and demonstrate the computational advantages of the forward methods.

Suggested Citation

  • Daniel Wei-Chung Miao & Yung-Hsin Lee & Jr-Yan Wang, 2018. "Using forward Monte-Carlo simulation for the valuation of American barrier options," Annals of Operations Research, Springer, vol. 264(1), pages 339-366, May.
    • Handle: RePEc:spr:annopr:v:264:y:2018:i:1:d:10.1007_s10479-017-2639-4
    DOI: 10.1007/s10479-017-2639-4
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    References listed on IDEAS

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