An Irregular Grid Approach for Pricing High-Dimensional American Options

S.J. Berridge, J.M. Schumacher

Research output: Working paperDiscussion paperOther research output

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Abstract

We propose and test a new method for pricing American options in a high-dimensional setting.The method is centred around the approximation of the associated complementarity problem on an irregular grid.We approximate the partial differential operator on this grid by appealing to the SDE representation of the underlying process and computing the root of the transition probability matrix of an approximating Markov chain.Experimental results in five dimensions are presented for four different payoff functions.
Original languageEnglish
Place of PublicationTilburg
PublisherFinance
Number of pages31
Volume2004-18
Publication statusPublished - 2004

Publication series

NameCentER Discussion Paper
Volume2004-18

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Markov processes
Costs

Keywords

  • option pricing
  • inequality
  • markov chains

Cite this

Berridge, S. J., & Schumacher, J. M. (2004). An Irregular Grid Approach for Pricing High-Dimensional American Options. (CentER Discussion Paper; Vol. 2004-18). Tilburg: Finance.
Berridge, S.J. ; Schumacher, J.M. / An Irregular Grid Approach for Pricing High-Dimensional American Options. Tilburg : Finance, 2004. (CentER Discussion Paper).
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Berridge, SJ & Schumacher, JM 2004 'An Irregular Grid Approach for Pricing High-Dimensional American Options' CentER Discussion Paper, vol. 2004-18, Finance, Tilburg.

An Irregular Grid Approach for Pricing High-Dimensional American Options. / Berridge, S.J.; Schumacher, J.M.

Tilburg : Finance, 2004. (CentER Discussion Paper; Vol. 2004-18).

Research output: Working paperDiscussion paperOther research output

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N2 - We propose and test a new method for pricing American options in a high-dimensional setting.The method is centred around the approximation of the associated complementarity problem on an irregular grid.We approximate the partial differential operator on this grid by appealing to the SDE representation of the underlying process and computing the root of the transition probability matrix of an approximating Markov chain.Experimental results in five dimensions are presented for four different payoff functions.

AB - We propose and test a new method for pricing American options in a high-dimensional setting.The method is centred around the approximation of the associated complementarity problem on an irregular grid.We approximate the partial differential operator on this grid by appealing to the SDE representation of the underlying process and computing the root of the transition probability matrix of an approximating Markov chain.Experimental results in five dimensions are presented for four different payoff functions.

KW - option pricing

KW - inequality

KW - markov chains

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Berridge SJ, Schumacher JM. An Irregular Grid Approach for Pricing High-Dimensional American Options. Tilburg: Finance. 2004. (CentER Discussion Paper).