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Valuing American Options Using Fast Recursive Projections

Author

Listed:
  • Antonio Cosma

    (Université du Luxembourg)

  • Stefano Galluccio

    (BNP Paribas Fixed Income)

  • Paola Pederzoli

    (University of Geneva)

  • O. Scaillet

    (University of Geneva GSEM and GFRI and Swiss Finance Institute)

Abstract

We introduce a fast and widely applicable numerical pricing method that uses recursive projections. We characterize its convergence speed. We find that the early exercise boundary of an American call option on a discrete dividend paying stock is higher under the Merton and Heston models than under the Black-Scholes model, as opposed to the continuous dividend case. A large database of call options on stocks with quarterly dividends shows that adding stochastic volatility and jumps to the Black-Scholes benchmark reduces the amount foregone by call holders failing to optimally exercise by 25\%. Transaction fees cannot fully explain the suboptimal behavior.

Suggested Citation

  • Antonio Cosma & Stefano Galluccio & Paola Pederzoli & O. Scaillet, "undated". "Valuing American Options Using Fast Recursive Projections," Swiss Finance Institute Research Paper Series 12-26, Swiss Finance Institute.
  • Handle: RePEc:chf:rpseri:rp1226
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques

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