scientific article; zbMATH DE number 1069621

Publication date 1 November 1998

American option approximation schemes benchmark comparisons comparative experiments

Microeconomic theory (price theory and economic markets) (91B24)

The overwhelming majority of traded options are of American type. Yet their valuation, even in the standard case of a lognormal process for the underlying asset, remains a topic of active research. This situation stems from the nature of the solution which requires the determination of the optimal exercise strategy as well as the value of the option. In contrast the European option, which can only be exercised at its expiration date, has been valued by the celebrated Black-Scholes formula (Black and Scholes 1973) for the standard financial model. Due to a lack of closed-form solutions to American option valuation problems, a vast array of approximation schemes has been advanced. The \textit{M. Broadie} and \textit{J. Detemple} article in this volume (see the paper reviewed below) provides a summary of some experimental results. The present article is a detailed account of comparative experiments conducted with numerical schemes including the recent method of Carr and Faguet (1996). It is organized as follows: Section 2 reviews the basic Black-Scholes model, Section 3 presents the approximation approaches and Section 4 concludes with some benchmark comparisons. For the entire collection see [Zbl 0867.00036].

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