On the methods of pricing American options: case study

AYDOGAN B., Aksoy U., UĞUR Ö.

ANNALS OF OPERATIONS RESEARCH, vol.260, pp.79-94, 2018 (SCI-Expanded) identifier identifier

  • Publication Type: Article / Article
  • Volume: 260
  • Publication Date: 2018
  • Doi Number: 10.1007/s10479-016-2267-4
  • Journal Name: ANNALS OF OPERATIONS RESEARCH
  • Journal Indexes: Science Citation Index Expanded (SCI-EXPANDED), Scopus
  • Page Numbers: pp.79-94
  • Middle East Technical University Affiliated: Yes

Abstract

In this study, a comparative analysis of numerical and approximation methods for pricing American options is performed. Binomial and finite difference approximations are discussed; furthermore, Roll-Geske-Whaley, Barone-Adesi and Whaley and Bjerksund-Stensland analytical approximations as well as the least-squares Monte Carlo method of Longstaff and Schwartz are presented. Applicability and efficiency in almost all circumstances, numerical solutions of the corresponding free boundary problem is emphasized. Methods used in pricing American options are also compared on dividend and non-dividend paying assets; and their pros and cons are discussed along with numerical experiments.