IDEAS home Printed from
   My bibliography  Save this article

Rationality Parameter for Exercising American Put


  • Kamille Sofie Tågholt Gad

    () (Department of Mathematical Sciences, University of Copenhagen, Universitetsparken 5, 2100 Copenhagen, Denmark)

  • Jesper Lund Pedersen

    () (Department of Mathematical Sciences, University of Copenhagen, Universitetsparken 5, 2100 Copenhagen, Denmark)


In this paper, irrational exercise behavior of the buyer of an American put is characterized by a single parameter. We model irrational exercise rules as the first jump time of a point processes with stochastic intensity. By the rationality parameter, we parameterize a family of stochastic intensities that depends on the value of the put itself. We present a probabilistic proof that the value of the American put using the irrational exercise rule converges to the arbitrage-free price as the rationality parameter converges to infinity. Another application of this result is the penalty method for approximating the price of an American put.

Suggested Citation

  • Kamille Sofie Tågholt Gad & Jesper Lund Pedersen, 2015. "Rationality Parameter for Exercising American Put," Risks, MDPI, Open Access Journal, vol. 3(2), pages 1-9, May.
  • Handle: RePEc:gam:jrisks:v:3:y:2015:i:2:p:103-111:d:49867

    Download full text from publisher

    File URL:
    Download Restriction: no

    File URL:
    Download Restriction: no

    References listed on IDEAS

    1. Chen, Hsiao-Chi & Friedman, James W. & Thisse, Jacques-Francois, 1997. "Boundedly Rational Nash Equilibrium: A Probabilistic Choice Approach," Games and Economic Behavior, Elsevier, vol. 18(1), pages 32-54, January.
    2. Dai, Min & Kwok, Yue Kuen & You, Hong, 2007. "Intensity-based framework and penalty formulation of optimal stopping problems," Journal of Economic Dynamics and Control, Elsevier, vol. 31(12), pages 3860-3880, December.
    3. Allen M. Poteshman & Vitaly Serbin, 2003. "Clearly Irrational Financial Market Behavior: Evidence from the Early Exercise of Exchange Traded Stock Options," Journal of Finance, American Finance Association, vol. 58(1), pages 37-70, February.
    Full references (including those not matched with items on IDEAS)


    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.

    Cited by:

    1. Rafael Company & Vera Egorova & Lucas J'odar & Fazlollah Soleymani, 2017. "Computing stable numerical solutions for multidimensional American option pricing problems: a semi-discretization approach," Papers 1701.08545,

    More about this item


    behavioral modeling; irrational exercise rule; partial differential equation; penalty method;

    JEL classification:

    • C - Mathematical and Quantitative Methods
    • G0 - Financial Economics - - General
    • G1 - Financial Economics - - General Financial Markets
    • G2 - Financial Economics - - Financial Institutions and Services
    • G3 - Financial Economics - - Corporate Finance and Governance
    • M2 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Economics
    • M4 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting
    • K2 - Law and Economics - - Regulation and Business Law


    Access and download statistics


    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:gam:jrisks:v:3:y:2015:i:2:p:103-111:d:49867. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (XML Conversion Team). General contact details of provider: .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.