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Pricing of American style options with an adjoint process correction method

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  • Jaekel, Uwe

Abstract

Pricing of American options is a more complicated problem than pricing of European options. In this work a formula is derived that allows the computation of the early exercise premium, i.e. the price difference between these two option types in terms of an adjoint process evolving in the reversed time direction of the original process determining the evolution of the European price. We show how this equation can be utilised to improve option price estimates from numerical schemes like finite difference or Monte Carlo methods.

Suggested Citation

  • Jaekel, Uwe, 2005. "Pricing of American style options with an adjoint process correction method," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 352(2), pages 584-600.
    • Handle: RePEc:eee:phsmap:v:352:y:2005:i:2:p:584-600
    DOI: 10.1016/j.physa.2005.01.015
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    References listed on IDEAS

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    1. Robert C. Merton, 2005. "Theory of rational option pricing," World Scientific Book Chapters, in: Sudipto Bhattacharya & George M Constantinides (ed.), Theory Of Valuation, chapter 8, pages 229-288, World Scientific Publishing Co. Pte. Ltd..
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    6. Kim, In Joon, 1990. "The Analytic Valuation of American Options," The Review of Financial Studies, Society for Financial Studies, vol. 3(4), pages 547-572.
    7. Peter Carr & Robert Jarrow & Ravi Myneni, 2008. "Alternative Characterizations Of American Put Options," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 5, pages 85-103, World Scientific Publishing Co. Pte. Ltd..
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