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Using Richardson extrapolation techniques to price American options with alternative stochastic processes

  • Chuang-Chang Chang
  • Jun-Biao Lin
  • Wei-Che Tsai
  • Yaw-Huei Wang

    ()

In this paper the authors investigate the performance of the original and repeated Richardson extrapolation methods for American option pricing by implementing both the original and modified Geske–Johnson approximation formulae. A comprehensive numerical comparison includes alternative stochastic processes of the underlying asset price. The numerical results show that whether the original or modified formula is implemented, the Richardson extrapolation techniques work very well. The repeated Richardson extrapolation strongly outperforms the original, especially when the underlying asset price follows a stochastic volatility process. Moreover, this study verifies the feasibility of the estimated error bounds of the American option prices under alternative stochastic processes by applying the repeated Richardson extrapolation method and estimating the interval of true American option values, as well as determining the number of options needed for an approximation to achieve a desired accuracy level. Copyright Springer Science+Business Media, LLC 2012

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File URL: http://hdl.handle.net/10.1007/s11156-011-0253-0
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Article provided by Springer in its journal Review of Quantitative Finance and Accounting.

Volume (Year): 39 (2012)
Issue (Month): 3 (October)
Pages: 383-406

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Handle: RePEc:kap:rqfnac:v:39:y:2012:i:3:p:383-406
Contact details of provider: Web page: http://springerlink.metapress.com/link.asp?id=102990

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