A product integration method for the approximation of the early exercise boundary in the American option pricing problem

DOI10.1002/MMA.5553zbMATH Open1414.91415arXiv1710.00161OpenAlexW2963090265MaRDI QIDQ5380932FDOQ5380932

Ali Foroush Bastani, Khadijeh Nedaiasl, Aysan Rafiee

Publication date: 6 June 2019

Published in: Mathematical Methods in the Applied Sciences (Search for Journal in Brave)

Abstract: In this paper, an integral equation representation for the early exercise boundary of an American option contract is considered. Thus far, a number of different techniques have been proposed in the literature to obtain a variety of integral equation forms for the early exercise boundary, all starting from the Black-Scholes partial differential equation. We first present a coherent categorization of exiting integral equation methodologies in the American option pricing literature. In the reminder and based on the fact that the early exercise boundary satisfies a fully nonlinear weakly singular non-standard Volterra integral equation, we propose a product integration approach based on linear barycentric rational interpolation to solve the problem. The price of the option will then be computed using the obtained approximation of the early exercise boundary and a barycentric rational quadrature. The convergence of the approximation scheme will also be analyzed. Finally, some numerical experiments based on the introduced method are presented and compared to some exiting approaches.

Full work available at URL: https://arxiv.org/abs/1710.00161

zbMATH Keywords

Volterra integral equationsbarycentric rational interpolationearly exercise boundaryinterpolatory quadratureAmerican options pricing

Mathematics Subject Classification ID

Derivative securities (option pricing, hedging, etc.) (91G20) Numerical methods (including Monte Carlo methods) (91G60) Numerical methods for integral equations (65R20) Volterra integral equations (45D05) Singular nonlinear integral equations (45G05) Approximation by rational functions (41A20)

Cited In (3)

• A fast sparse spectral method for nonlinear integro-differential Volterra equations with general kernels
• Title not available (Why is that?)
• Order allocation model in logistics service supply chain with demand updating and inequity aversion: a perspective of two option contracts comparison

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