American option pricing under stochastic volatility : a simulation-based approach

A. Chockalingam; K. Muthuraman

doi:10.1109/WSC.2007.4419696

American option pricing under stochastic volatility : a simulation-based approach

A. Chockalingam, K. Muthuraman

Research output: Chapter in Book/Report/Conference proceeding › Conference contribution › Academic › peer-review

3 Downloads (Pure)

Abstract

We consider the problem of pricing American options when the volatility of the underlying asset price is stochastic. No specific stochastic volatility model is assumed for the stochastic process. We propose a simulation-based approach to pricing such options. Iteratively, the method determines the optimal exercise boundary and the associated price function for a general stochastic volatility model. Given an initial guess of the optimal exercise boundary, the Retrospective Approximation (RA) technique is used to calculate the associated value function. Using this function, the exercise boundary is improved and the process repeated till convergence. This method is a simulation based variant of the exercise-policy improvement scheme developed in Chockalingam and Muthuraman (2007). An illustration of the method is provided when using the Heston (1993) model to represent the dynamics of the volatility, together with comparisons against existing methods to validate our numerical results.

Original language	English
Title of host publication	Proceedings of the 2007 Winter Simulation Conference
Editors	S.G. Henderson, B. Biller, M.H. Hsieh, J. Shortle, J.D. Tew, R.R. Barton
Place of Publication	Piscataway
Publisher	Institute of Electrical and Electronics Engineers
Pages	992-997
ISBN (Print)	978-1-4244-1306-5
DOIs	https://doi.org/10.1109/WSC.2007.4419696
Publication status	Published - 2007
Externally published	Yes
Event	2007 Winter Simulation Conference, WSC 2007 - Washington, United States Duration: 9 Dec 2007 → 12 Dec 2007

Conference

Conference	2007 Winter Simulation Conference, WSC 2007
Abbreviated title	WSC 2007
Country/Territory	United States
City	Washington
Period	9/12/07 → 12/12/07

Access to Document

10.1109/WSC.2007.4419696

Cite this

Chockalingam, A., & Muthuraman, K. (2007). American option pricing under stochastic volatility : a simulation-based approach. In S. G. Henderson, B. Biller, M. H. Hsieh, J. Shortle, J. D. Tew, & R. R. Barton (Eds.), Proceedings of the 2007 Winter Simulation Conference (pp. 992-997). Institute of Electrical and Electronics Engineers. https://doi.org/10.1109/WSC.2007.4419696

@inproceedings{81521ccba113432cb8d44e0010849613,

title = "American option pricing under stochastic volatility : a simulation-based approach",

abstract = "We consider the problem of pricing American options when the volatility of the underlying asset price is stochastic. No specific stochastic volatility model is assumed for the stochastic process. We propose a simulation-based approach to pricing such options. Iteratively, the method determines the optimal exercise boundary and the associated price function for a general stochastic volatility model. Given an initial guess of the optimal exercise boundary, the Retrospective Approximation (RA) technique is used to calculate the associated value function. Using this function, the exercise boundary is improved and the process repeated till convergence. This method is a simulation based variant of the exercise-policy improvement scheme developed in Chockalingam and Muthuraman (2007). An illustration of the method is provided when using the Heston (1993) model to represent the dynamics of the volatility, together with comparisons against existing methods to validate our numerical results.",

author = "A. Chockalingam and K. Muthuraman",

year = "2007",

doi = "10.1109/WSC.2007.4419696",

language = "English",

isbn = "978-1-4244-1306-5",

pages = "992--997",

editor = "S.G. Henderson and B. Biller and M.H. Hsieh and J. Shortle and J.D. Tew and R.R. Barton",

booktitle = "Proceedings of the 2007 Winter Simulation Conference",

publisher = "Institute of Electrical and Electronics Engineers",

address = "United States",

note = "2007 Winter Simulation Conference, WSC 2007, WSC 2007 ; Conference date: 09-12-2007 Through 12-12-2007",

}

Chockalingam, A & Muthuraman, K 2007, American option pricing under stochastic volatility : a simulation-based approach. in SG Henderson, B Biller, MH Hsieh, J Shortle, JD Tew & RR Barton (eds), Proceedings of the 2007 Winter Simulation Conference. Institute of Electrical and Electronics Engineers, Piscataway, pp. 992-997, 2007 Winter Simulation Conference, WSC 2007, Washington, District of Columbia, United States, 9/12/07. https://doi.org/10.1109/WSC.2007.4419696

American option pricing under stochastic volatility : a simulation-based approach. / Chockalingam, A.; Muthuraman, K.
Proceedings of the 2007 Winter Simulation Conference. ed. / S.G. Henderson; B. Biller; M.H. Hsieh; J. Shortle; J.D. Tew; R.R. Barton. Piscataway: Institute of Electrical and Electronics Engineers, 2007. p. 992-997.

Research output: Chapter in Book/Report/Conference proceeding › Conference contribution › Academic › peer-review

TY - GEN

T1 - American option pricing under stochastic volatility : a simulation-based approach

AU - Chockalingam, A.

AU - Muthuraman, K.

PY - 2007

Y1 - 2007

N2 - We consider the problem of pricing American options when the volatility of the underlying asset price is stochastic. No specific stochastic volatility model is assumed for the stochastic process. We propose a simulation-based approach to pricing such options. Iteratively, the method determines the optimal exercise boundary and the associated price function for a general stochastic volatility model. Given an initial guess of the optimal exercise boundary, the Retrospective Approximation (RA) technique is used to calculate the associated value function. Using this function, the exercise boundary is improved and the process repeated till convergence. This method is a simulation based variant of the exercise-policy improvement scheme developed in Chockalingam and Muthuraman (2007). An illustration of the method is provided when using the Heston (1993) model to represent the dynamics of the volatility, together with comparisons against existing methods to validate our numerical results.

AB - We consider the problem of pricing American options when the volatility of the underlying asset price is stochastic. No specific stochastic volatility model is assumed for the stochastic process. We propose a simulation-based approach to pricing such options. Iteratively, the method determines the optimal exercise boundary and the associated price function for a general stochastic volatility model. Given an initial guess of the optimal exercise boundary, the Retrospective Approximation (RA) technique is used to calculate the associated value function. Using this function, the exercise boundary is improved and the process repeated till convergence. This method is a simulation based variant of the exercise-policy improvement scheme developed in Chockalingam and Muthuraman (2007). An illustration of the method is provided when using the Heston (1993) model to represent the dynamics of the volatility, together with comparisons against existing methods to validate our numerical results.

U2 - 10.1109/WSC.2007.4419696

DO - 10.1109/WSC.2007.4419696

M3 - Conference contribution

SN - 978-1-4244-1306-5

SP - 992

EP - 997

BT - Proceedings of the 2007 Winter Simulation Conference

A2 - Henderson, S.G.

A2 - Biller, B.

A2 - Hsieh, M.H.

A2 - Shortle, J.

A2 - Tew, J.D.

A2 - Barton, R.R.

PB - Institute of Electrical and Electronics Engineers

CY - Piscataway

T2 - 2007 Winter Simulation Conference, WSC 2007

Y2 - 9 December 2007 through 12 December 2007

ER -

American option pricing under stochastic volatility : a simulation-based approach

Abstract

Conference

Access to Document

Fingerprint

Cite this