Truncation and Acceleration of the Tian Tree for the Pricing of American Put Options

18 Pages Posted: 9 Mar 2010

See all articles by Ting Chen

Ting Chen

University of Melbourne - Centre for Actuarial Studies

Mark S. Joshi

University of Melbourne - Centre for Actuarial Studies (deceased)

Date Written: March 8, 2010

Abstract

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

Chen, Ting and Joshi, Mark, Truncation and Acceleration of the Tian Tree for the Pricing of American Put Options (March 8, 2010). Available at SSRN: https://ssrn.com/abstract=1567218 or http://dx.doi.org/10.2139/ssrn.1567218

Ting Chen

University of Melbourne - Centre for Actuarial Studies ( email )

Melbourne, 3010
Australia

Mark Joshi (Contact Author)

University of Melbourne - Centre for Actuarial Studies (deceased) ( email )

Melbourne, 3010
Australia

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