On the Robustness of Least - Squares Monte Carlo (LSM) for Pricing American Derivatives
University of Castilla-La Mancha
Javier F. Navas
Pablo de Olavide University
Review of Derivatives Research, Vol. 6, No. 2, 2003
This paper analyses the robustness of Least - Squares Monte Carlo, a technique proposed by Longstaff and Schwartz (2001) for pricing American options. This method is based on least - squares regressions in which the explanatory variables are certain polynomial functions. We analyze the impact of different basis functions on option prices. Numerical results for American put options show that this approach is quite robust to the choice of basis functions. For more complex derivatives, this choice can slightly affect option prices.
Number of Pages in PDF File: 41
Keywords: Least-Squares Monte Carlo, Option Pricing, American Options
JEL Classification: C15, C60, G13Accepted Paper Series
Date posted: November 20, 2007 ; Last revised: December 7, 2007
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