Pricing an American Option by Approximating Its Early Exercise Boundary As a Piece-Wise Exponential Function
Nengjiu Ju
Hong Kong University of Science & Technology - Department of Finance
February 12, 1997
Abstract:
This paper proposes to price an American option by approximating its early exercise boundary as a piece-wise exponential function. Closed-form formulas are obtained in terms of the bases and exponents of the piece-wise exponential function. It is demonstrated that a three-point extrapolation scheme has the accuracy of an 800-time-step binomial tree, but about 130 times faster. An intuitive argument is given to indicate why this seemingly crude approximation works so well. Our method is very simple and easy to implement. Comparisons with other leading competing methods are also included.
Number of Pages in PDF File: 26
JEL Classification: G13
working papers series
Suggested Citation
Ju, Nengjiu, Pricing an American Option by Approximating Its Early Exercise Boundary As a Piece-Wise Exponential Function (February 12, 1997). Available at SSRN: http://ssrn.com/abstract=362 or http://dx.doi.org/10.2139/ssrn.362
