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Pricing American Options under Stochastic Volatility and Stochastic Interest Rates

Author

Listed:
  • Alexey MEDVEDEV

    (Banquier Privé Lombard Odier and Swiss Finance Institute)

  • Olivier SCAILLET

    (University of Geneva, HEC and Swiss Finance Institute)

Abstract

We introduce a new analytical approach to price American options. Using an explicit and intuitive proxy for the exercise rule, we derive tractable pricing formulas using a short-maturity asymptotic expansion. Depending on model parameters, this method can accurately price options with time-to-maturity up to several years. The main advantage of our approach over existing methods lies in its straightforward extension to models with stochastic volatility and stochastic interest rates. We exploit this advantage by providing an analysis of the impact of volatility mean-reversion, volatility of volatility, and correlations on the American put price.

Suggested Citation

  • Alexey MEDVEDEV & Olivier SCAILLET, 2007. "Pricing American Options under Stochastic Volatility and Stochastic Interest Rates," Swiss Finance Institute Research Paper Series 07-25, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp0725
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    File URL: http://ssrn.com/abstract=966055
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    More about this item

    Keywords

    American options; stochastic volatility; stochastic interest rates; asymptotic approximation.;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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