Enhanced Monte Carlo Estimates for American Option Prices

J. OF DERIVATIVES, Fall 1997

Posted: 6 Nov 1997

See all articles by Mark Broadie

Mark Broadie

Columbia University - Columbia Business School - Decision Risk and Operations

Paul Glasserman

Columbia Business School

Gautam Jain

L.O.G. International Corp.

Abstract

Monte Carlo simulation has trouble with American options because the exercise decision at a given date must compare the option's immediate exercise value against its continuation value. The option value if it is not exercised is a function of its value along all possible future price paths from that point on, and each path will present further exercise decisions with the same difficulty in resolving them. The authors propose a hybrid valuation technique that bridges Monte Carlo simulation and lattice methods. Instead of simulating price paths, they simulate whole price trees. The tree emanating from each point is used to assess the option continuation value for that date and stock price. While the results are accurate, inevitably the procedure requires a large number of computations. The authors then offer a variety of techniques that substantially increase efficiency.

JEL Classification: G13, C63

Suggested Citation

Broadie, Mark and Glasserman, Paul and Jain, Gautam, Enhanced Monte Carlo Estimates for American Option Prices. J. OF DERIVATIVES, Fall 1997, Available at SSRN: https://ssrn.com/abstract=11257

Mark Broadie (Contact Author)

Columbia University - Columbia Business School - Decision Risk and Operations ( email )

New York, NY
United States
212-854-4103 (Phone)

Paul Glasserman

Columbia Business School ( email )

3022 Broadway
403 Uris Hall
New York, NY 10027
United States
212-854-4102 (Phone)
212-316-9180 (Fax)

Gautam Jain

L.O.G. International Corp.

New York, NY

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