Reference : Valuing American options using fast recursive projections
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Business & economic sciences : Finance
Valuing American options using fast recursive projections
Cosma, Antonio mailto [University of Luxembourg > Faculty of Law, Economics and Finance (FDEF) > Center for Research in Economic Analysis (CREA) >]
Galluccio, Stefano [Incipit Capital, London]
Pederzoli, Paola [University of Geneva and Swiss Finance Institute]
Scaillet, Olivier [University of Geneva and Swiss Finance Institute]
[en] Option pricing ; American option ; Bermudan option ; discrete transform ; discrete dividend paying stock ; suboptimal non-exercise ; numerical techniques
[en] We introduce a fast and widely applicable numerical pricing method that uses recursive projections. We characterize its convergence speed. We find that the early exercise boundary of an American call option on a discrete dividend paying stock is higher under the Merton and Heston models than under the Black-Scholes model, as opposed to the continuous dividend case. A large database of call options on stocks with quarterly dividends shows that adding stochastic volatility and jumps to the Black-Scholes benchmark reduces the amount foregone by call holders failing to optimally exercise by 25%. Transaction fees cannot fully explain the suboptimal behavior.

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