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Backward simulation methods for pricing American options under the CIR process

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  • Wenbin Hu
  • Junzi Zhou

Abstract

In this paper, we focus on backward simulation of the CIR process. The purpose is to solve the memory requirement issue of the Least Squares Monte Carlo method when pricing American options by simulation. The concept of backward simulation is presented and it is classified into two types. Under the framework of the second type backward simulation, we seek the solutions for the existing CIR schemes. Specifically, we propose forward–backward simulation approaches for Alfonsi’s two implicit schemes, the fixed Euler schemes and the exact scheme. The proposed schemes are numerically tested and compared in pricing American options under the Heston model and the stochastic interest rate model. Some numerical properties such as the convergence order of the explicit–implicit Euler schemes, the storage requirement estimation of the forward–backward exact scheme and its computing time comparison with the squared Bessel bridge are also tested. Finally, the pros and cons of the related backward simulation schemes are summarized.

Suggested Citation

  • Wenbin Hu & Junzi Zhou, 2017. "Backward simulation methods for pricing American options under the CIR process," Quantitative Finance, Taylor & Francis Journals, vol. 17(11), pages 1683-1695, November.
    • Handle: RePEc:taf:quantf:v:17:y:2017:i:11:p:1683-1695
    DOI: 10.1080/14697688.2017.1307513
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    References listed on IDEAS

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    Cited by:

    1. M. Gardini & P. Sabino & E. Sasso, 2021. "The Variance Gamma++ Process and Applications to Energy Markets," Papers 2106.15452, arXiv.org.

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