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Faster Comparison of Stopping Times by Nested Conditional Monte Carlo

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  • Fabian Dickmann
  • Nikolaus Schweizer

Abstract

We show that deliberately introducing a nested simulation stage can lead to significant variance reductions when comparing two stopping times by Monte Carlo. We derive the optimal number of nested simulations and prove that the algorithm is remarkably robust to misspecifications of this number. The method is applied to several problems related to Bermudan/American options. In these applications, our method allows to substantially increase the efficiency of other variance reduction techniques, namely, Quasi-Control Variates and Multilevel Monte Carlo.

Suggested Citation

  • Fabian Dickmann & Nikolaus Schweizer, 2014. "Faster Comparison of Stopping Times by Nested Conditional Monte Carlo," Papers 1402.0243, arXiv.org.
  • Handle: RePEc:arx:papers:1402.0243
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    File URL: http://arxiv.org/pdf/1402.0243
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    References listed on IDEAS

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    1. Leif Andersen & Mark Broadie, 2004. "Primal-Dual Simulation Algorithm for Pricing Multidimensional American Options," Management Science, INFORMS, vol. 50(9), pages 1222-1234, September.
    2. Longstaff, Francis A & Schwartz, Eduardo S, 2001. "Valuing American Options by Simulation: A Simple Least-Squares Approach," Review of Financial Studies, Society for Financial Studies, vol. 14(1), pages 113-147.
    3. Boyle, Phelim & Broadie, Mark & Glasserman, Paul, 1997. "Monte Carlo methods for security pricing," Journal of Economic Dynamics and Control, Elsevier, vol. 21(8-9), pages 1267-1321, June.
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    5. Paul Glasserman & Philip Heidelberger & Perwez Shahabuddin & Tim Zajic, 1999. "Multilevel Splitting for Estimating Rare Event Probabilities," Operations Research, INFORMS, vol. 47(4), pages 585-600, August.
    6. Martin B. Haugh & Leonid Kogan, 2004. "Pricing American Options: A Duality Approach," Operations Research, INFORMS, vol. 52(2), pages 258-270, April.
    7. Denis Belomestny & Fabian Dickmann & Tigran Nagapetyan, 2013. "Pricing American options via multi-level approximation methods," Papers 1303.1334, arXiv.org, revised Dec 2013.
    8. Youyi Feng & Guillermo Gallego, 1995. "Optimal Starting Times for End-of-Season Sales and Optimal Stopping Times for Promotional Fares," Management Science, INFORMS, vol. 41(8), pages 1371-1391, August.
    9. Denis Belomestny, 2009. "Pricing Bermudan options using nonparametric regression: optimal rates of convergence for lower estimates," Papers 0907.5599, arXiv.org.
    10. repec:esr:wpaper:rsnote2012/3/1 is not listed on IDEAS
    11. L. C. G. Rogers, 2002. "Monte Carlo valuation of American options," Mathematical Finance, Wiley Blackwell, vol. 12(3), pages 271-286.
    12. Asmussen, S. & Binswanger, K., 1997. "Simulation of Ruin Probabilities for Subexponential Claims," ASTIN Bulletin: The Journal of the International Actuarial Association, Cambridge University Press, vol. 27(02), pages 297-318, November.
    13. Mark Broadie & Yiping Du & Ciamac C. Moallemi, 2011. "Efficient Risk Estimation via Nested Sequential Simulation," Management Science, INFORMS, vol. 57(6), pages 1172-1194, June.
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