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An improved method for pricing and hedging long dated American options
journal contribution
posted on 2023-06-09, 20:29 authored by Frank J Fabozzi, Tommaso Paletta, Silvia Stanescu, Radu TunaruRadu TunaruThe majority of quasi-analytic pricing methods for American options are efficient near maturity but are prone to larger errors when time-to-maturity increases. We introduce a new methodology to increase the accuracy of almost any existing quasi-analytic approach in pricing long-maturity American options. The new methodology, called the “extension-method”, relies on an approximation of the optimal exercise price near the beginning of the contract combined with existing pricing approaches so that the maturity range for which small errors are attainable is extended. Our method retains the quasi-analytic nature of the methods it improves. Generic quasi-analytic formulae for the price of an American put as well as for its hedging parameter are derived. Our scenarios-based numerical study indicates that our method considerably improves both the pricing and the hedging performance of a number of established approaches for a wide range of maturities. The superiority of this approach is illustrated with real financial data by considering S&P 100TM LEAPS® options traded from January 2008 to May 2015.
History
Publication status
- Published
File Version
- Accepted version
Journal
European Journal of Operational ResearchISSN
0377-2217Publisher
ElsevierExternal DOI
Issue
2Volume
254Page range
656-666Department affiliated with
- Accounting and Finance Publications
Research groups affiliated with
- Quantitative International Finance Network Publications
Full text available
- Yes
Peer reviewed?
- Yes
Legacy Posted Date
2020-02-03First Open Access (FOA) Date
2020-02-03First Compliant Deposit (FCD) Date
2020-01-31Usage metrics
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