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An FBSDE Approach to American Option Pricing with an Interacting Particle Method

Author

Listed:
  • Masaaki Fujii

    (The University of Tokyo)

  • Seisho Sato

    (The University of Tokyo)

  • Akihiko Takahashi

    (The University of Tokyo)

Abstract

In the paper, we propose a new calculation scheme for American options in the framework of a forward backward stochastic di erential 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 & Takahashi (2012c), 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 e ectiveness of the particle method.

Suggested Citation

  • Masaaki Fujii & Seisho Sato & Akihiko Takahashi, 2014. "An FBSDE Approach to American Option Pricing with an Interacting Particle Method," CARF F-Series CARF-F-352, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
  • Handle: RePEc:cfi:fseres:cf352
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    References listed on IDEAS

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    1. Akihiko Takahashi & Kohta Takehara & Masashi Toda, 2011. "A General Computation Scheme for a High-Order Asymptotic Expansion Method," CIRJE F-Series CIRJE-F-787, CIRJE, Faculty of Economics, University of Tokyo.
    2. Marek Rutkowski, 1994. "The Early Exercise Premium Representation Of Foreign Market American Options1," Mathematical Finance, Wiley Blackwell, vol. 4(4), pages 313-325, October.
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    4. N. El Karoui & S. Peng & M. C. Quenez, 1997. "Backward Stochastic Differential Equations in Finance," Mathematical Finance, Wiley Blackwell, vol. 7(1), pages 1-71, January.
    5. Akihiko Takahashi & Kohta Takehara & Masashi Toda, 2011. "A General Computation Scheme for a High-Order Asymptotic Expansion Method," CARF F-Series CARF-F-242, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo, revised Jul 2011.
    6. Duffie, Darrell & Huang, Ming, 1996. "Swap Rates and Credit Quality," Journal of Finance, American Finance Association, vol. 51(3), pages 921-949, July.
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    Cited by:

    1. Akihiko Takahashi & Toshihiro Yamada, 2015. "An Asymptotic Expansion of Forward-Backward SDEs with a Perturbed Driver," CARF F-Series CARF-F-363, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
    2. Masaaki Fujii & Akihiko Takahashi, 2015. "Perturbative Expansion Technique for Non-linear FBSDEs with Interacting Particle Method," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 22(3), pages 283-304, September.
    3. Masaaki Fujii & Akihiko Takahshi, 2015. "Perturbative Expansion Technique for Non-linear FBSDEs with Interacting Particle Method," CIRJE F-Series CIRJE-F-954, CIRJE, Faculty of Economics, University of Tokyo.
    4. Stéphane Crépey & Shiqi Song, 2014. "Counterparty risk and funding: Immersion and beyond," Working Papers hal-00989062, HAL.
    5. Akihiko Takahashi & Toshihiro Yamada, 2015. "An asymptotic expansion of forward-backward SDEs with a perturbed driver," International Journal of Financial Engineering (IJFE), World Scientific Publishing Co. Pte. Ltd., vol. 2(02), pages 1-29.
    6. Akihiko Takahashi & Toshiaki Watanabe, 2015. "An Asymptotic Expansion of Forward-Backward SDEs with a Perturbed Driver ," CIRJE F-Series CIRJE-F-976, CIRJE, Faculty of Economics, University of Tokyo.

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