Leave-One-Out Least Square Monte Carlo Algorithm for Pricing American Options

23 Pages Posted: 28 Oct 2018 Last revised: 28 May 2019

See all articles by Jeechul Woo

Jeechul Woo

University of Illinois Urbana-Champaign

Chenru Liu

Peking University - HSBC Business School; Stanford University, School of Engineering, Management Science & Engineering, Students

Jaehyuk Choi

Peking University - HSBC School of Business

Date Written: October 3, 2018

Abstract

The least square Monte Carlo (LSM) algorithm proposed by Longstaff and Schwartz [2001] is widely used for pricing American options. The LSM estimator contains undesirable look-ahead bias, and the conventional technique of removing it necessitates doubling simulations. We present the leave-one-out LSM (LOOLSM) algorithm for efficiently eliminating look-ahead bias. We validate the method with several option examples, including the multi-asset cases that the LSM algorithm significantly overvalues. We also obtain the convergence rates of look-ahead bias by measuring it using the LOOLSM method. The analysis and computational evidence support our findings.

Keywords: American option, Least square Monte Carlo, Longstaff--Schwartz algorithm, Look-ahead bias, Leave-one-out-cross-validation

JEL Classification: C61, G13

Suggested Citation

Woo, Jeechul and Liu, Chenru and Choi, Jaehyuk, Leave-One-Out Least Square Monte Carlo Algorithm for Pricing American Options (October 3, 2018). Available at SSRN: https://ssrn.com/abstract=3260372 or http://dx.doi.org/10.2139/ssrn.3260372

Jeechul Woo

University of Illinois Urbana-Champaign ( email )

1409 W Green
Urbana, IL 61801
United States

Chenru Liu

Peking University - HSBC Business School ( email )

No. 38 Xueyuan Road
Haidian District
Beijing, Beijing 100871
China

Stanford University, School of Engineering, Management Science & Engineering, Students ( email )

473 Via Ortega
Stanford, CA 94305-9025
United States

Jaehyuk Choi (Contact Author)

Peking University - HSBC School of Business ( email )

University Town
Shenzhen, Guangdong 518055
China

HOME PAGE: http://www.jaehyukchoi.net/phbs_en

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