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Swing Option Pricing By Dynamic Programming With B-Spline Density Projection

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  • J. LARS KIRKBY

    (School of Industrial and Systems Engineering, Georgia Institute of Technology, 755 Ferst Drive, NW, Atlanta, GA 30332, USA)

  • SHI-JIE DENG

    (School of Industrial and Systems Engineering, Georgia Institute of Technology, 755 Ferst Drive, NW, Atlanta, GA 30332, USA)

Abstract

Swing options are a type of exotic financial derivative which generalize American options to allow for multiple early-exercise actions during the contract period. These contracts are widely traded in commodity and energy markets, but are often difficult to value using standard techniques due to their complexity and strong path-dependency. There are numerous interesting varieties of swing options, which differ in terms of their intermediate cash flows, and the constraints (both local and global) which they impose on early-exercise (swing) decisions. We introduce an efficient and general purpose transform-based method for pricing discrete and continuously monitored swing options under exponential Lévy models, which applies to contracts with fixed rights clauses, as well as recovery time delays between exercise. The approach combines dynamic programming with an efficient method for calculating the continuation value between monitoring dates, and applies generally to multiple early-exercise contracts, providing a unified framework for pricing a large class of exotic derivatives. Efficiency and accuracy of the method are supported by a series of numerical experiments which further provide benchmark prices for future research.

Suggested Citation

  • J. Lars Kirkby & Shi-Jie Deng, 2019. "Swing Option Pricing By Dynamic Programming With B-Spline Density Projection," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 22(08), pages 1-53, December.
    • Handle: RePEc:wsi:ijtafx:v:22:y:2019:i:08:n:s0219024919500389
    DOI: 10.1142/S0219024919500389
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