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Optimal Exercise Policies and Simulation-Based Valuation for American-Asian Options

Author

Listed:
  • Rongwen Wu

    (Department of Mathematics, University of Maryland, College Park, Maryland 20742)

  • Michael C. Fu

    (The Robert H. Smith School of Business, University of Maryland, College Park, Maryland 20742-1815)

Abstract

American-Asian options are average-price options that allow early exercise. In this paper, we derive structural properties for the optimal exercise policy, which are then used to develop an efficient numerical algorithm for pricing such options. In particular, we show that the optimal policy is a threshold policy: The option should be exercised as soon as the average asset price reaches a characterized threshold, which can be written as a function of the asset price at that time. By exploiting this and other structural properties, we are able to parameterize the exercise boundary, and derive gradient estimators for the option payoff with respect to the parameters of the model. These estimators are then incorporated into a simulation-based algorithm to price American-Asian options. Computational experiments carried out indicate that the algorithm is very competitive with other recently proposed numerical algorithms.

Suggested Citation

  • Rongwen Wu & Michael C. Fu, 2003. "Optimal Exercise Policies and Simulation-Based Valuation for American-Asian Options," Operations Research, INFORMS, vol. 51(1), pages 52-66, February.
    • Handle: RePEc:inm:oropre:v:51:y:2003:i:1:p:52-66
    DOI: 10.1287/opre.51.1.52.12798
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    References listed on IDEAS

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    Cited by:

    1. Kailin Ding & Zhenyu Cui & Xiaoguang Yang, 2023. "Pricing arithmetic Asian and Amerasian options: A diffusion operator integral expansion approach," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 43(2), pages 217-241, February.
    2. Min Dai & Yue Kuen Kwok, 2006. "Characterization Of Optimal Stopping Regions Of American Asian And Lookback Options," Mathematical Finance, Wiley Blackwell, vol. 16(1), pages 63-82, January.
    3. Scott B. Laprise & Michael C. Fu & Steven I. Marcus & Andrew E. B. Lim & Huiju Zhang, 2006. "Pricing American-Style Derivatives with European Call Options," Management Science, INFORMS, vol. 52(1), pages 95-110, January.
    4. Andrea Pascucci, 2008. "Free boundary and optimal stopping problems for American Asian options," Finance and Stochastics, Springer, vol. 12(1), pages 21-41, January.
    5. Mabel C. Chou & Mahmut Parlar & Yun Zhou, 2017. "Optimal Timing to Initiate Medical Treatment for a Disease Evolving as a Semi-Markov Process," Journal of Optimization Theory and Applications, Springer, vol. 175(1), pages 194-217, October.
    6. Michael C. Fu, 2008. "What you should know about simulation and derivatives," Naval Research Logistics (NRL), John Wiley & Sons, vol. 55(8), pages 723-736, December.
    7. Tomas Bokes & Daniel Sevcovic, 2009. "Early exercise boundary for American type of floating strike Asian option and its numerical approximation," Papers 0912.1321, arXiv.org.

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