Truncation and Acceleration of the Tian Tree for the Pricing of American Put Options
18 Pages Posted: 9 Mar 2010
Date Written: March 8, 2010
We present a new method for truncating binomial trees based on using a tolerance to control truncation errors and apply it to the Tian tree together with acceleration techniques of smoothing and Richardson extrapolation. For both the current (based on standard deviations) and the new (based on tolerance) truncation methods, we test different truncation criteria, levels and replacement values to obtain the best combination for each required level of accuracy. We also provide numerical results demonstrating that the new method can be 50% faster than previously presented methods when pricing American put options in the Black-Scholes model.
Keywords: American put, binomial tree, truncation
JEL Classification: C15, G13
Suggested Citation: Suggested Citation