A Simple and Numerically Efficient Valuation Method for American Puts Using a Modified Geske-Johnson Approach

Authors

  • DAVID S. BUNCH,

  • HERB JOHNSON

    Search for more papers by this author
    • Graduate School of Management, University of California, Davis, and Graduate School of Management, University of California, Riverside, respectively. We are grateful to Warren Bailey and Rick Castanias for helpful comments on an earlier draft, and to Fred Vetter for assistance in programming and testing the methods. We are also indebted to an anonymous referee for several suggestions that improved the manuscript. The usual caveat applies.

ABSTRACT

Geske and Johnson (1984) develop an equation for the American put price and obtain accurate prices using a method requiring quadrivariate normal integrals evaluated over an interval containing four equally spaced exercise points. We show that a modification of their method which uses optimal placement of exercise points yields in most cases accurate values using nothing more than bivariate normals. In the more difficult (deep-in-the-money) cases, trivariate normals suffice.

Ancillary