On the robustness of least-squares Monte Carlo (LSM) for pricing American derivatives
Abstract
This paper analyses the robustness of Least-Squares Monte Carlo, a technique recently proposed by Longstaff and Schwartz (2001) for pricing American options. This method is based on least-squares regressions in which the explanatory variables are certain polynomial functions. We analyze the impact of different basis functions on option prices. Numerical results for American put options provide evidence that a) this approach is very robust to the choice of different alternative polynomials and b) few basis functions are required. However, these conclusions are not reached when analyzing more complex derivatives.Download Info
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Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 543.Length:
Date of creation: Apr 2001
Date of revision:
Handle: RePEc:upf:upfgen:543
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Web page: http://www.econ.upf.edu/
Related research
Keywords: Least-Squares Monte Carlo; option pricing; American options;Other versions of this item:
- Manuel Moreno & Javier Navas, 2003. "On the Robustness of Least-Squares Monte Carlo (LSM) for Pricing American Derivatives," Review of Derivatives Research, Springer, vol. 6(2), pages 107-128, May.
- C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
- C60 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - General
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
This paper has been announced in the following NEP Reports:
- NEP-ALL-2001-05-16 (All new papers)
- NEP-CMP-2001-05-16 (Computational Economics)
- NEP-FIN-2001-05-16 (Finance)
References
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Citations
Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.Cited by:
- Li, Minqiang, 2009.
"A Quasi-analytical Interpolation Method for Pricing American Options under General Multi-dimensional Diffusion Processes,"
MPRA Paper
17348, University Library of Munich, Germany.
- Minqiang Li, 2010. "A quasi-analytical interpolation method for pricing American options under general multi-dimensional diffusion processes," Review of Derivatives Research, Springer, vol. 13(2), pages 177-217, July.
- Farid AitSahlia & Manisha Goswami & Suchandan Guha, 2010. "American option pricing under stochastic volatility: an efficient numerical approach," Computational Management Science, Springer, vol. 7(2), pages 171-187, April.
- Cartea, Álvaro & Williams, Thomas, 2008.
"UK gas markets : the market price of risk and applications to multiple interruptible supply contracts,"
Open Access publications from Universidad Carlos III de Madrid
info:hdl:10016/12175, Universidad Carlos III de Madrid.
- Cartea, Álvaro & Williams, Thomas, 2008. "UK gas markets: The market price of risk and applications to multiple interruptible supply contracts," Energy Economics, Elsevier, vol. 30(3), pages 829-846, May.
- Alvaro Cartea & Thomas Williams, 2006. "UK Gas Markets: the Market Price of Risk and Applications to Multiple Interruptible Supply Contracts," Birkbeck Working Papers in Economics and Finance 0608, Birkbeck, Department of Economics, Mathematics & Statistics.
- Cartea, Álvaro & Williams, Thomas, . "UK gas markets : the market price of risk and applications to multiple interruptible supply contracts," Open Access publications from Universidad Carlos III de Madrid info:hdl:10016/12124, Universidad Carlos III de Madrid.
- Nelson Areal & Artur Rodrigues & Manuel Armada, 2008. "On improving the least squares Monte Carlo option valuation method," Review of Derivatives Research, Springer, vol. 11(1), pages 119-151, March.
- Berridge, S.J. & Schumacher, J.M., 2002.
"An Irregular Grid Approach for Pricing High Dimensional American Options,"
Discussion Paper
2002-99, Tilburg University, Center for Economic Research.
- Berridge, S.J. & Schumacher, J.M., 2004. "An Irregular Grid Approach for Pricing High-Dimensional American Options," Discussion Paper 2004-18, Tilburg University, Center for Economic Research.
- Guglielmo Maria Caporale & Mario Cerrato, 2005.
"Valuing American Put Options Using Chebyshev Polynomial Approximation,"
Public Policy Discussion Papers
05-03, Economics and Finance Section, School of Social Sciences, Brunel University.
- Guglielmo Maria Caporale & Mario Cerrato, 2005. "Valuing American Put Options Using Chebyshev Polynomial Approximation," Economics and Finance Discussion Papers 05-03, Economics and Finance Section, School of Social Sciences, Brunel University.
- Carmona, Julio & León, Angel & Vaello-Sebastià, Antoni, 2012.
"Does stock return predictability affect ESO fair value?,"
European Journal of Operational Research,
Elsevier, vol. 223(1), pages 188-202.
- Carmona, Julio & León, Angel & Vaello-Sebastiá, Antoni, 2011. "Does Stock Return Predictability Affect ESO Fair Value?," QM&ET Working Papers 11-2, Universidad de Alicante, Departamento de Métodos Cuantitativos y Teoría Económica, revised 16 Jan 2012.
- Alexander Boogert & Cyriel de Jong, 2007. "Gas Storage Valuation Using a Monte Carlo Method," Birkbeck Working Papers in Economics and Finance 0704, Birkbeck, Department of Economics, Mathematics & Statistics.
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