Approximating the exact value of an American option

Authors

  • Stefano Herzel Università degli Studi di Perugia

DOI:

https://doi.org/10.6092/issn.1973-2201/39

Abstract

An American option is a derivative security that can be exercised at any time before expiration. Under standard hypotheses it can be shown that its arbitrage-free price is the solution of an optimal stopping problem. Usually, if the underlying asset follows a diffusion, the stopping time problem does not have a closed form solution. Therefore, discrete time models have been proposed to determine an approximated solution. I formulate some conditions on the discrete process to insure convergence of the approximations to the exact value. I also show how to apply such conditions to check the correctness of some of the most popular discretization schemes.

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How to Cite

Herzel, S. (2004). Approximating the exact value of an American option. Statistica, 64(2), 287–304. https://doi.org/10.6092/issn.1973-2201/39

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