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Functional convergence of Snell envelopes: Applications to American options approximations

  • Maurizio Pratelli

    (Dipartimento di Matematica, UniversitÁ di Pisa, Via Buonarroti 2, I-56100 Pisa, Italy Manuscript)

  • Sabrina Mulinacci

    (Istituto di Econometria e Matematica per le Decisioni Economiche, UniversitÁ Cattolica del S. Cuore, Via Necchi 9, I-20131 Milano, Italy)

Registered author(s):

    The main result of the paper is a stability theorem for the Snell envelope under convergence in distribution of the underlying processes: more precisely, we prove that if a sequence $(X^n)$ of stochastic processes converges in distribution for the Skorokhod topology to a process $X$ and satisfies some additional hypotheses, the sequence of Snell envelopes converges in distribution for the Meyer-Zheng topology to the Snell envelope of $X$ (a brief account of this rather neglected topology is given in the appendix). When the Snell envelope of the limit process is continuous, the convergence is in fact in the Skorokhod sense. This result is illustrated by several examples of approximations of the American options prices; we give moreover a kind of robustness of the optimal hedging portfolio for the American put in the Black and Scholes model.

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    Article provided by Springer in its journal Finance and Stochastics.

    Volume (Year): 2 (1998)
    Issue (Month): 3 ()
    Pages: 311-327

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    Handle: RePEc:spr:finsto:v:2:y:1998:i:3:p:311-327
    Note: received: January 1996; final version received: July 1997
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