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A Simple American Option Pricing Method Using The Fast Fourier Transform

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  • SUNEAL K. CHAUDHARY

    (Mathematics Department, Monmouth University, West Long Branch, NJ 07764, USA)

Abstract

This paper describes a fast, flexible numerical technique to price American options and generate their value surface through time. The method runs faster and more accurately than the standard CRR binomial method in practical cases and calculates options on a considerably broader family of new, useful underlying asset processes. The technique relies on the Fast Fourier Transform (FFT) to convolve a transition function for the underlying asset process. The method allows the underlying asset process to be quite general; the previously known standard geometric Brownian motion and the Variance Gamma process [8], and a novel, purely empirical transition function are compared by computing their respective American put value surface and the exercise boundaries.

Suggested Citation

  • Suneal K. Chaudhary, 2007. "A Simple American Option Pricing Method Using The Fast Fourier Transform," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 10(07), pages 1191-1202.
    • Handle: RePEc:wsi:ijtafx:v:10:y:2007:i:07:n:s0219024907004603
    DOI: 10.1142/S0219024907004603
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    References listed on IDEAS

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    1. Richard Bellman, 1957. "On a Dynamic Programming Approach to the Caterer Problem--I," Management Science, INFORMS, vol. 3(3), pages 270-278, April.
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    Cited by:

    1. Giacomo Bormetti & Sofia Cazzaniga, 2014. "Multiplicative noise, fast convolution and pricing," Quantitative Finance, Taylor & Francis Journals, vol. 14(3), pages 481-494, March.

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