American Option Pricing with Discrete and Continuous Time Models: An Empirical Comparison

49 Pages Posted: 2 Jul 2011

See all articles by Lars Stentoft

Lars Stentoft

Department of Economics, University of Western Ontario; Center for Interuniversity Research and Analysis on Organization (CIRANO); Aarhus University - CREATES

Date Written: June 30, 2011

Abstract

This paper considers discrete time GARCH and continuous time SV models and uses these for American option pricing. We perform a Monte Carlo study to examine their differences in terms of option pricing, and we study the convergence of the discrete time option prices to their implied continuous time values. Finally, a large scale empirical analysis using individual stock options and options on an index is performed comparing the estimated prices from discrete time models to the corresponding continuous time model prices. The results indicate that, while the differences in performance are small overall, for in the money options the continuous time SV models do generally perform better than the discrete time GARCH specifications.

Keywords: American Options, Augmented GARCH, Least Squares Monte Carlo, Stochastic Volatility

JEL Classification: C22, C53, G13

Suggested Citation

Stentoft, Lars, American Option Pricing with Discrete and Continuous Time Models: An Empirical Comparison (June 30, 2011). Available at SSRN: https://ssrn.com/abstract=1875847 or http://dx.doi.org/10.2139/ssrn.1875847

Lars Stentoft (Contact Author)

Department of Economics, University of Western Ontario ( email )

London, Ontario N6A 5B8
Canada

Center for Interuniversity Research and Analysis on Organization (CIRANO)

2020 rue University, 25th floor
Montreal H3C 3J7, Quebec
Canada

Aarhus University - CREATES

School of Economics and Management
Building 1322, Bartholins Alle 10
DK-8000 Aarhus C
Denmark

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