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Gradient-enhanced sparse Hermite polynomial expansions for pricing and hedging high-dimensional American options

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  • Jiefei Yang
  • Guanglian Li

Abstract

We propose an efficient and easy-to-implement gradient-enhanced least squares Monte Carlo method for computing price and Greeks (i.e., derivatives of the price function) of high-dimensional American options. It employs the sparse Hermite polynomial expansion as a surrogate model for the continuation value function, and essentially exploits the fast evaluation of gradients. The expansion coefficients are computed by solving a linear least squares problem that is enhanced by gradient information of simulated paths. We analyze the convergence of the proposed method, and establish an error estimate in terms of the best approximation error in the weighted $H^1$ space, the statistical error of solving discrete least squares problems, and the time step size. We present comprehensive numerical experiments to illustrate the performance of the proposed method. The results show that it outperforms the state-of-the-art least squares Monte Carlo method with more accurate price, Greeks, and optimal exercise strategies in high dimensions but with nearly identical computational cost, and it can deliver comparable results with recent neural network-based methods up to dimension 100.

Suggested Citation

  • Jiefei Yang & Guanglian Li, 2024. "Gradient-enhanced sparse Hermite polynomial expansions for pricing and hedging high-dimensional American options," Papers 2405.02570, arXiv.org.
    • Handle: RePEc:arx:papers:2405.02570
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    References listed on IDEAS

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    1. Longstaff, Francis A & Schwartz, Eduardo S, 2001. "Valuing American Options by Simulation: A Simple Least-Squares Approach," The Review of Financial Studies, Society for Financial Studies, vol. 14(1), pages 113-147.
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    5. Sebastian Becker & Patrick Cheridito & Arnulf Jentzen, 2019. "Pricing and hedging American-style options with deep learning," Papers 1912.11060, arXiv.org, revised Jul 2020.
    6. Jiefei Yang & Guanglian Li, 2023. "On Sparse Grid Interpolation for American Option Pricing with Multiple Underlying Assets," Papers 2309.08287, arXiv.org, revised Sep 2023.
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