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Monte Carlo Pricing of American Options Using Nonparametric Regression

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Author Info

  • Pizzi Claudio

    (Universita' Ca' Foscari, Venice)

  • Pellizzari Paolo

    (universita' Ca' Foscari, Venice)

Abstract

This paper provides an introduction to Monte Carlo algorithms for pricing American options written on multiple assets, with special emphasis on methods that can be applied in a multi-dimensional setting. Simulated paths can be used to estimate by nonparametric regression the continuation value of the option or the optimal exercise policy and the value functions can then be computed by backward induction. The flexibility of nonparametric regression allows to obtain accurate price estimates with remarkable speed. For illustrative purposes we price one- and two-dimensional American options.

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File URL: http://128.118.178.162/eps/fin/papers/0207/0207007.pdf
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Bibliographic Info

Paper provided by EconWPA in its series Finance with number 0207007.

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Length: 345 pages
Date of creation: 19 Aug 2002
Date of revision: 04 Mar 2003
Handle: RePEc:wpa:wuwpfi:0207007

Note: Type of Document - pdf; prepared on OzTeX on Macintosh; to print on Laser printer; pages: 345,395,4323247 ; figures: included
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Web page: http://128.118.178.162

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Keywords: Option pricing; American options; Monte Carlo; nonparametric regression;

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References

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  1. Huang, Jing-zhi & Subrahmanyam, Marti G & Yu, G George, 1996. "Pricing and Hedging American Options: A Recursive Integration Method," Review of Financial Studies, Society for Financial Studies, vol. 9(1), pages 277-300.
  2. Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, vol. 7(3), pages 229-263, September.
  3. Barraquand, Jérôme & Martineau, Didier, 1995. "Numerical Valuation of High Dimensional Multivariate American Securities," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 30(03), pages 383-405, September.
  4. 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.
  5. Boyle, Phelim P., 1988. "A Lattice Framework for Option Pricing with Two State Variables," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 23(01), pages 1-12, March.
  6. Barone-Adesi, Giovanni & Whaley, Robert E, 1987. " Efficient Analytic Approximation of American Option Values," Journal of Finance, American Finance Association, vol. 42(2), pages 301-20, June.
  7. Carr, Peter, 1998. "Randomization and the American Put," Review of Financial Studies, Society for Financial Studies, vol. 11(3), pages 597-626.
  8. Geske, Robert & Johnson, Herb E, 1984. " The American Put Option Valued Analytically," Journal of Finance, American Finance Association, vol. 39(5), pages 1511-24, December.
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Cited by:
  1. Maximilian Mair & Jan Maruhn, 2013. "On the primal-dual algorithm for callable Bermudan options," Review of Derivatives Research, Springer, vol. 16(1), pages 79-110, April.

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