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The Valuation of American Options with Stochastic Stopping Time Constraints

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Author Info

  • Daniel Egloff
  • Markus Leippold

Abstract

This paper concerns the pricing of American options with stochastic stopping time constraints expressed in terms of the states of a Markov process. Following the ideas of Menaldi et al., we transform the constrained into an unconstrained optimal stopping problem. The transformation replaces the original payoff by the value of a generalized barrier option. We also provide a Monte Carlo method to numerically calculate the option value for multidimensional Markov processes. We adapt the Longstaff-Schwartz algorithm to solve the stochastic Cauchy-Dirichlet problem related to the valuation problem of the barrier option along a set of simulated trajectories of the underlying Markov process.

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File URL: http://www.tandfonline.com/doi/abs/10.1080/13504860802645706
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Bibliographic Info

Article provided by Taylor & Francis Journals in its journal Applied Mathematical Finance.

Volume (Year): 16 (2009)
Issue (Month): 3 ()
Pages: 287-305

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Handle: RePEc:taf:apmtfi:v:16:y:2009:i:3:p:287-305

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Related research

Keywords: American options; optimal stopping under constraints; Feller process; out-performance options; management options; Monte Carlo simulation;

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