Primal-Dual Simulation Algorithm for Pricing Multidimensional American Options

This paper describes a practical algorithm based on Monte Carlo simulation for the pricing of multidimensional American (i.e., continuously exercisable) and Bermudan (i.e., discretely exercisable) options. The method generates both lower and upper bounds for the Bermudan option price and hence gives...

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Veröffentlicht in:Management science Jg. 50; H. 9; S. 1222 - 1234
Hauptverfasser: Andersen, Leif, Broadie, Mark
Format: Journal Article
Sprache:Englisch
Veröffentlicht: Linthicum INFORMS 01.09.2004
Institute for Operations Research and the Management Sciences
Schriftenreihe:Management Science
Schlagworte:
Algorithms
American option
American options
Approximation
Bermudan options
Bermudan swaptions
Binomials
Business studies
Capital market
Confidence interval
Libor market model
Management science
Martingales
Mathematical models
Methods
Monte Carlo method
Monte Carlo methods
Monte Carlo simulation
multiple state variables
Option pricing
Options (Finance)
Options markets
Options on stocks
Prices and rates
Pricing
Pricing policies
real options
Simplicity
Simulation
Specification
Standard deviation
Studies
U.S.A
Valuation
Value
Working papers
United States > US
ISSN:0025-1909, 1526-5501
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Beschreibung
Zusammenfassung:This paper describes a practical algorithm based on Monte Carlo simulation for the pricing of multidimensional American (i.e., continuously exercisable) and Bermudan (i.e., discretely exercisable) options. The method generates both lower and upper bounds for the Bermudan option price and hence gives valid confidence intervals for the true value. Lower bounds can be generated using any number of primal algorithms. Upper bounds are generated using a new Monte Carlo algorithm based on the duality representation of the Bermudan value function suggested independently in Haugh and Kogan (2004) and Rogers (2002). Our proposed algorithm can handle virtually any type of process dynamics, factor structure, and payout specification. Computational results for a variety of multifactor equity and interest-rate options demonstrate the simplicity and efficiency of the proposed algorithm. In particular, we use the proposed method to examine and verify the tightness of frequently used exercise rules in Bermudan swaption markets.
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ISSN:0025-1909
1526-5501
DOI:10.1287/mnsc.1040.0258