A Replicating Portfolio Approach to Valuing American Options in Closed-Form

12 Pages Posted: 9 Jan 2021 Last revised: 19 Feb 2021

Date Written: November 19, 2020

Abstract

I derive closed-form expressions for the value of American call and put options (on an asset with continuous yield) using the Feynman-Kac formula, modelling the size of early exercise premium as a function of the strike, dividend yield and time to maturity. Strategies involving European options and binary options on forwards on the asset replicate an American option exactly. Violations of Put-Call parity for American options is also explored in this framework.

Keywords: Rational Pricing, American Options, Static Replicating Portfolio

JEL Classification: C32, G13

Suggested Citation

Khan, Muhammad, A Replicating Portfolio Approach to Valuing American Options in Closed-Form (November 19, 2020). Available at SSRN: https://ssrn.com/abstract=3733258 or http://dx.doi.org/10.2139/ssrn.3733258

Muhammad Khan (Contact Author)

New York University ( email )

Department of Economics, GSAS
19 West 4th Street, 6th Floor
New York, NY 10012-8600
United States

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