Analytical Approximations for the Critical Stock Prices of American Options: A Performance Comparison
27 Pages Posted: 4 Oct 2009
Date Written: October 3, 2009
Many efficient and accurate analytical methods for pricing American options now exist. However, while they can produce accurate option prices, they often do not give accurate critical stock prices. In this paper, we propose two new analytical approximations for American options based on the quadratic approximation. We compare our methods with existing analytical methods including the quadratic approximations in Barone-Adesi and Whaley (1987) and Barone-Adesi and Elliott (1991), the lower bound approximation in Broadie and Detemple (1996), the tangent approximation in Bunch and Johnson (2000), the Laplace inversion method in Zhu (2006b), and the interpolation method in Li (2008). Both of our methods give much more accurate critical stock prices than all the existing methods above.
Keywords: American option, Analytical approximation, Critical stock price
JEL Classification: C02, C63, G13
Suggested Citation: Suggested Citation