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Application of simplest random walk algorithms for pricing barrier options

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  • M. Krivko
  • M. V. Tretyakov

Abstract

We demonstrate effectiveness of the first-order algorithm from [Milstein, Tretyakov. Theory Prob. Appl. 47 (2002), 53-68] in application to barrier option pricing. The algorithm uses the weak Euler approximation far from barriers and a special construction motivated by linear interpolation of the price near barriers. It is easy to implement and is universal: it can be applied to various structures of the contracts including derivatives on multi-asset correlated underlyings and can deal with various type of barriers. In contrast to the Brownian bridge techniques currently commonly used for pricing barrier options, the algorithm tested here does not require knowledge of trigger probabilities nor their estimates. We illustrate this algorithm via pricing a barrier caplet, barrier trigger swap and barrier swaption.

Suggested Citation

  • M. Krivko & M. V. Tretyakov, 2012. "Application of simplest random walk algorithms for pricing barrier options," Papers 1211.5726, arXiv.org.
    • Handle: RePEc:arx:papers:1211.5726
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    References listed on IDEAS

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    1. Naoto Kunitomo & Masayuki Ikeda, 1992. "Pricing Options With Curved Boundaries1," Mathematical Finance, Wiley Blackwell, vol. 2(4), pages 275-298, October.
    2. Emmanuel Gobet, 2009. "Advanced Monte Carlo methods for barrier and related exotic options," Post-Print hal-00319947, HAL.
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