An FBSDE Approach to American Option Pricing with an Interacting Particle Method
In the paper, we propose a new calculation scheme for American options in the framework of a forward backward stochastic differential equation (FBSDE). The well-known decomposition of an American option price with that of a European option of the same maturity and the remaining early exercise premium can be cast into the form of a decoupled non-linear FBSDE. We numerically solve the FBSDE by applying an interacting particle method recently proposed by Fujii and Takahashi (2012d), which allows one to perform a Monte Carlo simulation in a fully forward-looking manner. We perform the fourth-order analysis for the Black-Scholes (BS) model and the third-order analysis for the Heston model. The comparison to those obtained from existing tree algorithms shows the effectiveness of the particle method.
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Marek Rutkowski, 1994. "The Early Exercise Premium Representation Of Foreign Market American Options," Mathematical Finance, Wiley Blackwell, vol. 4(4), pages 313-325.
- Masaaki Fujii & Akihiko Takahashi, 2011. "Analytical Approximation for Non-linear FBSDEs with Perturbation Scheme," Papers 1106.0123, arXiv.org, revised Jan 2012.
- Masaaki Fujii & Akihiko Takahashi, 2012. "Perturbative Expansion of FBSDE in an Incomplete Market with Stochastic Volatility," Papers 1202.0608, arXiv.org, revised Sep 2012.
- Duffie, Darrell & Huang, Ming, 1996. " Swap Rates and Credit Quality," Journal of Finance, American Finance Association, vol. 51(3), pages 921-949, July.
- S. D. Jacka, 1991. "Optimal Stopping and the American Put," Mathematical Finance, Wiley Blackwell, vol. 1(2), pages 1-14.
- Masaaki Fujii & Akihiko Takahashi, 2012. "ANALYTICAL APPROXIMATION FOR NON-LINEAR FBSDEs WITH PERTURBATION SCHEME," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 15(05), pages 1-24.
When requesting a correction, please mention this item's handle: RePEc:arx:papers:1211.5867. 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: (arXiv administrators)
If references are entirely missing, you can add them using this form.