Pricing American Option Based on a Chebyshev Approximation of the Early Exercise Boundary

35 Pages Posted: 24 Feb 2002

See all articles by Elias Tzavalis

Elias Tzavalis

University of London - Queen Mary - Department of Economics

Shijun Wang

Queen Mary, University of London - Department of Economics

Abstract

In this paper we introduce a new method of pricing an American call option by approximating its early exercise boundary based on Chebyshev polynomial functions. We implement the method to price options under the standard assumptions of the Black-Scholes model, for European options, and under stochastic volatility. For the latter, we provide an integral representation which unbundles the American call option price to Arrow-Debreu security prices. Numerical results indicate that our method is an effective alternative to other exercise boundary approximation methods under both the standard assumptions of the Black-Scholes and stochastic volatility.

Keywords: American option price, early exercise boundary, Chebyshev approximation, stochastic volatility

JEL Classification: G13

Suggested Citation

Tzavalis, Elias and Wang, Shijun, Pricing American Option Based on a Chebyshev Approximation of the Early Exercise Boundary. Available at SSRN: https://ssrn.com/abstract=301186 or http://dx.doi.org/10.2139/ssrn.301186

Elias Tzavalis

University of London - Queen Mary - Department of Economics ( email )

Mile End Road
London, E1 4NS
United Kingdom

HOME PAGE: http//www.qmw.ac.uk/~ugte184/

Shijun Wang (Contact Author)

Queen Mary, University of London - Department of Economics ( email )

Mile End Road
London, E1 4NS
United Kingdom

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