Gaussian Quadrature Method for Pricing American and Exotic Options in a Jump-Diffusion Process

31 Pages Posted: 18 May 2017

See all articles by Pei-Shih Weng

Pei-Shih Weng

National Dong Hwa University

Wei-Che Tsai

Oregon State University; National Sun Yat-sen University - Department of Finance

Date Written: November 30, 2015

Abstract

In this paper we propose a Gaussian quadrature method to study American and exotic option pricing under the jump-diffusion model of Merton (1976). Our numerical experiments show that the Gaussian quadrature method, compared to several existing methods in the literature, including the fast Gauss transform method (Broadie and Yamamoto, 2003), the bivariate tree approach (Hilliard and Schwartz, 2005), and the extrapolation approach (Feng and Linetsky, 2008), is accurate for valuing American options. In addition to American options, we also show that the Gaussian quadrature method performs well for the valuation of exotic options under the jump-diffusion model. Overall, the Gaussian quadrature method is highly accurate and suitable for the valuation of price options with early exercise features under a jump-diffusion process.

Keywords: Option Pricing; Numerical Quadrature; Jump-Diffusion Model

JEL Classification: G13

Suggested Citation

Weng, Pei-Shih and Tsai, Wei-Che, Gaussian Quadrature Method for Pricing American and Exotic Options in a Jump-Diffusion Process (November 30, 2015). Available at SSRN: https://ssrn.com/abstract=2968823 or http://dx.doi.org/10.2139/ssrn.2968823

Pei-Shih Weng

National Dong Hwa University ( email )

No. 1, Sec. 2, Da Hsueh Rd.
Shoufeng, Hualien 97401
Taiwan

Wei-Che Tsai (Contact Author)

Oregon State University ( email )

Corvallis, OR 97331
United States

National Sun Yat-sen University - Department of Finance ( email )

No.70, Lianhai Rd., Gushan District,
Kaohsiung City
Taiwan

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