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

DOI10.1002/MMA.5553MaRDI QIDQ5380932zbMATH OpenOpenAlexFDO

Authors Khadijeh Nedaiasl, Ali Foroush Bastani, Aysan Rafiee

Publication date 6 June 2019

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

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)

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.

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