We are grateful for the helpful comments and suggestions from Bob Webb (Editor) and an anonymous referee.
A Forward Monte Carlo Method for American Options Pricing
Version of Record online: 7 FEB 2012
© 2012 Wiley Periodicals, Inc.
Journal of Futures Markets
Volume 33, Issue 4, pages 369–395, April 2013
How to Cite
Miao, D. W.-C. and Lee, Y.-H. (2013), A Forward Monte Carlo Method for American Options Pricing. J. Fut. Mark., 33: 369–395. doi: 10.1002/fut.21549
- Issue online: 7 JAN 2013
- Version of Record online: 7 FEB 2012
- Manuscript Accepted: 5 DEC 2011
- Manuscript Received: 26 MAY 2011
This study proposes a forward Monte Carlo method for the pricing of American options. The main advantage of this method is that it does not use backward induction as required by other methods. Instead, the proposed approach relies on a wise determination about whether a simulated stock price has entered the exercise region. The validity of the proposed method is supported by the mathematical proofs for the vanilla cases. With some adaption, it is shown that this forward method can be extended to price other American style options such as chooser and exchange options. This study demonstrates the effectiveness of the proposed approach using a series of numerical examples, revealing significant improvements in numerical efficiency and accuracy in contrast with the standard regression-based method of Longstaff and Schwartz (2001). © 2012 Wiley Periodicals, Inc. Jrl Fut Mark 33:369-395, 2013