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Valuing American Derivatives by Least Squares Methods

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Author Info
Mario Cerrato

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Abstract

Least Squares estimators are notoriously known to generate sub-optimal exercise decisions when determining the optimal stopping time. The consequence is that the price of the option will be underestimated. We show how to use variance reduction techniques to extend some recent Monte Carlo estimators for option pricing and assess their performance in finite samples. Finally, we extend the Longstaff and Schwartz (2001) method to price American options under stochastic volatility. This is the first study to implement and apply the Glasserman and Yu (2004b) methodology to price Asian options and basket options.

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Publisher Info
Paper provided by Department of Economics, University of Glasgow in its series Working Papers with number 2008_12.

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Date of creation: Apr 2008
Date of revision: Sep 2008
Handle: RePEc:gla:glaewp:2008_12

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Postal: Adam Smith Building, University of Glasgow, Glasgow G12 8RT
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Web page: http://www.gla.ac.uk/departments/economics/
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Related research
Keywords: American options; Monte Carlo method;

Find related papers by JEL classification:
G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

References listed on IDEAS
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  1. Boyle, Phelim & Broadie, Mark & Glasserman, Paul, 1997. "Monte Carlo methods for security pricing," Journal of Economic Dynamics and Control, Elsevier, vol. 21(8-9), pages 1267-1321, June. [Downloadable!] (restricted)
  2. Abadir, K.M., 1995. "On Efficient Simulations in Dynamic Models," Discussion Papers 95/21, University of Exeter, School of Business and Economics.
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  3. Philip Protter & Emmanuelle Clément & Damien Lamberton, 2002. "An analysis of a least squares regression method for American option pricing," Finance and Stochastics, Springer, vol. 6(4), pages 449-471. [Downloadable!] (restricted)
  4. Lars Stentoft, 2004. "Assessing the Least Squares Monte-Carlo Approach to American Option Valuation," Review of Derivatives Research, Springer, vol. 7(2), pages 129-168, 08. [Downloadable!]
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