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A simpler algorithm to price American Lookback options in a discrete stochastic volatility model

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  • L. Ramprasath

    (Indian Institute of Management Kozhikode)

Abstract

This article develops an efficient pricing algorithm for American lookback options on a binomial lattice with stochastic volatility. This is achieved by combining the structure of this lattice together with the fact that one can price lookbacks on a standard binomial lattice without having to store the path variables. We apply this algorithm to study the efficiency of fractional lookback contracts, which are used as a benchmark for designing equity indexed annuities, and illustrate the impact of volatility persistence on their prices. This algorithm also extends the usefulness of the stochastic volatility model proposed by Aingworth, Das and Motwani (2006) by enabling the pricing of lookback options on their lattice.

Suggested Citation

  • L. Ramprasath, 2018. "A simpler algorithm to price American Lookback options in a discrete stochastic volatility model," Working papers 294, Indian Institute of Management Kozhikode.
    • Handle: RePEc:iik:wpaper:294
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    References listed on IDEAS

    as
    1. Tze Leung Lai & Tiong Wee Lim, 2004. "Exercise Regions And Efficient Valuation Of American Lookback Options," Mathematical Finance, Wiley Blackwell, vol. 14(2), pages 249-269, April.
    2. Heston, Steven L, 1993. "A Closed-Form Solution for Options with Stochastic Volatility with Applications to Bond and Currency Options," The Review of Financial Studies, Society for Financial Studies, vol. 6(2), pages 327-343.
    3. Donald Aingworth & Sanjiv Das & Rajeev Motwani, 2006. "A simple approach for pricing equity options with Markov switching state variables," Quantitative Finance, Taylor & Francis Journals, vol. 6(2), pages 95-105.
    4. Hans Gerber & Elias Shiu, 2003. "Pricing Lookback Options and Dynamic Guarantees," North American Actuarial Journal, Taylor & Francis Journals, vol. 7(1), pages 48-66.
    5. Cheuk, Terry H. F. & Vorst, Ton C. F., 1997. "Currency lookback options and observation frequency: A binomial approach," Journal of International Money and Finance, Elsevier, vol. 16(2), pages 173-187, April.
    6. Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, vol. 7(3), pages 229-263, September.
    7. Massimo Costabile & Arturo Leccadito & Ivar Massabó & Emilio Russo, 2014. "A reduced lattice model for option pricing under regime-switching," Review of Quantitative Finance and Accounting, Springer, vol. 42(4), pages 667-690, May.
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