Jun Liu is thanked for encouraging this research from the very beginning, and Chong Jiang is thanked for bringing the implied binomial tree method to Qiang's attention. The authors are truly grateful to the anonymous reviewer for suggesting the inclusion of hedging performance in the study, for helping improve the scholarship of the study in numerous ways, and for expediting the review process. The editorial support from Editor Robert Webb is sincerely appreciated without any reservation. The work is supported by a key research grant from Project 211 (Phase III) of Southwestern University of Finance and Economics, by Huaxi Futures Co., Ltd., and by Tri-Spring Steel Trades Co., Ltd.
Canonical Distribution, Implied Binomial Tree, and the Pricing of American Options
Article first published online: 24 OCT 2011
© 2012 Wiley Periodicals, Inc.
Journal of Futures Markets
Volume 33, Issue 2, pages 183–198, February 2013
How to Cite
Liu, Q. and Guo, S. (2013), Canonical Distribution, Implied Binomial Tree, and the Pricing of American Options. J. Fut. Mark., 33: 183–198. doi: 10.1002/fut.20555
- Issue published online: 19 NOV 2012
- Article first published online: 24 OCT 2011
- Manuscript Accepted: 17 SEP 2011
- Manuscript Received: 12 MAY 2011
In this study, a new approach to pricing American options is proposed and termed the canonical implied binomial (CIB) tree method. CIB takes advantage of both canonical valuation (Stutzer, 1996) and the implied binomial tree method (Rubinstein, 1994). Using simulated returns from geometric Brownian motions (GBM), CIB produced very similar prices for calls and European puts as those of Black–Scholes (BS). Applied to a set of over 15,000 American-style S&P 100 Index puts, CIB outperformed BS with historic volatility in pricing out-of-the-money options; in addition, it outperformed the canonical least-squares Monte Carlo (Liu, 2010) in the dynamic hedging of in-the-money options. Furthermore, CIB suggests that regular GBM-based Monte Carlo can be extended to American options pricing by also utilizing the implied binomial tree. © 2011 Wiley Periodicals, Inc. Jrl Fut Mark